Exits speak louder than words

Surveys on the private equity market almost invariably seek to grab the attention with blithe assertions of “new investment soars” or “fundraising plummets”. In reality, there is no such thing as black and white when it comes to private equity performance because hidden behind the attentiongrabbing headlines are all manner of complexities.

Therefore, Stefan Hepp, chief executive of Swiss gatekeeper Strategic Capital Management (SCM), comes across as refreshingly honest when he says: “The first lesson with private equity statistics is “be cynical”. If you ask different people, you will come up with different answers and there is no comprehensive way of finding out what is really going on.”

That is not to say that SCM's own 2003 Annual Exit Analysis should not be taken seriously. SCM is, after all, a gatekeeper and – as such – surely in as good a position as any organisation to demand quality information from general partners it knows. That said, SCM does not claim to paint as comprehensive a picture as some other data gatherers. For example, in its 2002 annual survey of private equity activity, the European Venture Capital and Private Equity Association (EVCA) boasted 1,112 responses out of 1,500 GPs canvassed around Europe. This compares with responses from 103 partnerships managed by 50 GPs in both Europe and the US that are covered by the SCM study.

Hepp claims that his firm's statistics give an accurate indication of exits delivered by funds that are active in the market. Of course one person's definition of “active” may differ from the next, but what SCM is striving to reflect is exit activity among those types of funds that limited partners are likely to be investing in at the current time. This is important. It means for example that the European sample is strongly biased towards buyouts (80 percent of respondents) as against venture (7 percent) – reflecting the current unpopularity of the latter. The US sample again reflects a buyout bias, though less pronounced (40 percent buyout to 25 percent venture) given the out-performance of some US venture funds.

With these qualifications in mind, it's worth taking a closer look at some of the survey's key findings:

  • • European exits up, US exits down: Overall, the total number of exits increased 21 percent by number and 14 percent by value in 2003 compared with the previous year. But the experience of Europe, where exits rose 39 percent, was very different from the US, where they fell 21 percent. “There is more restructuring and repositioning in Europe, which has resulted in a larger population of trade buyers than in the US,” says Hepp. However, the bias towards buyout funds in the survey is also a factor, as it fails to reflect the relative exit success of US venture investors versus their European counterparts. The 21 percent increase in the number of exits in Europe compares with a three percent increase recorded by the EVCA over the same period, suggesting that the EVCA's broader universe of respondents includes many less active funds and probably more from the venture ranks.
  • • Secondary buyouts now accepted: There are pragmatic reasons for the growth of the secondary buyout. When fundraising, for example, there is no more convenient way of evidencing to potential investors an ability to exit transactions than by selling assets to fellow funds. But the strength of the trend points to something more significant: namely, secondary buyouts have lost the bad taste they once left in the mouths of most limited partners. “In the past, there was a feeling among fund investors that they should not be paying managers simply to shuffle assets,” says Hepp. “Now they don't care.” What matters, it seems, is that the exit is achieved – and not how one went about achieving it.
  • • Absence of secondary venture deals a problem: Given the predominance of secondary buyouts, why do we hear nothing of secondary venture deals? Hepp says it is a mystery, particularly given how tough it is to exit via IPO. “What I hear at conferences these days is that to IPO successfully, a business needs $100 million turnover and two to three established product lines. If that's true, there should be merger mania in VC land – but there's not. Perhaps this is because venture capital has been characterised recently by bargain hunting and vulture behaviour, which doesn't strengthen the communal spirit. [GP] Investors also have shallow pockets and may simply lack the capital to help their portfolios build critical mass.” An absence of co-operation among VCs could have grave consequences at a time when the IPO market remains unpredictable (see below).
  • • Mixed messages from IPO market: Among European respondents, the share of exits via IPO remained the same between 2002 and 2003: at 11 percent. This contrasts with EVCA figures over the same period showing a decline from 13 percent of the total to nine percent. This would appear to be linked to the greater percentage of venture firms canvassed by the EVCA. “The lack of venture-backed IPOs suggests that what some people see as the recovery of venture is overrated,” says Hepp. “Great returns in venture are driven by the IPO, not just in terms of the occasional big winner, but also the way in which the possibility of an IPO has an impact on valuation.” A recovery in the US IPO market meant that the share of total exits enjoyed by IPOs from all funds climbed from 16 percent to 19 percent.
  • • l Is the worst over for venture? A fall in exits by write-off, from 28 percent of the total in 2002 to 21 percent last year, leads Hepp to conclude that the fallout from the technology crash is subsiding and that the worst times are over for the VCs [buyout never plumbed the same depths]. This is a comforting conclusion for the industry but just to prove the original point that all data is open to interpretation, there is always a contrarian view. When quizzed about these findings, Mark Pacitti, a partner in the London office of Deloitte, commented: “Venture is always difficult and the worst is not necessarily behind it. In buyout deals, banks are getting excitable and prices are increasing again. It's a worrying sign, even though the performance of the underlying assets is good.”