The two reporters from Private Equity International arrive at TPG’s opulent Carlton Gardens offices on one of those weirdly cold, wet and overcast early-summer afternoons that Londoners have had to get used to in recent years.
We’re due to meet co-founder David Bonderman for a conversation mainly about the firm’s approach to ESG-compliant private equity investing. According to people who know him well, the TPG co-founder is a non-sceptic when it comes to climate change, and so given our agenda, the gloomy skies above the city provide a suitable-seeming backdrop.
Ever the globetrotter, Bonderman has flown in from California to meet with colleagues and investors, and also for an on-stage interview at Private Equity International’s and the UN PRI’s Responsible Investment Forum the following day. To prep for the event, he’s brought along TPG’s in-house ESG advisors Edward Norton and Elisabeth Lowery, and together with European fundraiser Magnus Christensson and public affairs chief Adam Levine, we all meet in the boardroom to talk through the game-plan for tomorrow’s interview.
THIS ISN’T BOX-TICKING
Bonderman has a well-earned reputation for being interesting on pretty much any subject, and ESG is no exception. A former student of archeology who became involved in the environment while doing excavation work in the Grand Canyon, he says his views on the matter have shaped the TPG culture right from the start in 1992.
Likewise with regards to social considerations: the firm made it a point of principle at the outset not to invest in industries such as guns and tobacco, and continues to follow this rule to the present day. As Bonderman puts it: “Things that kill people, we try to stay away from.”
To be sure, Bonderman thinks the ESG acronym’s usefulness has its limitations: its bundling of what inherently are three distinct sets of issues – Environmental, Social and Governance – risks obscuring the fact that each of them poses its own kind of challenge to investors and therefore requires skilled management in its own right. And notably in his view, some of them are more difficult to handle for private equity than others.
Of the three, according to Bonderman, the governance issue should be the easiest nut to crack. Private equity, even when it doesn’t own a majority stake in an asset, is by definition expected to exert strong influence over the business. So when a governance problem arises, a capable manager should be able to resolve it without much difficulty: “The governance part of ESG, to my thinking, is actually sort of semi-irrelevant to our industry: we rarely invest where we don’t have some say in what’s happening. And if the CEO is doing a bad job running the company and we own the company, we get someone else to do it; we shouldn’t have to think twice about it.”
With the environmental and social dimensions of private equity investing, things are less straightforward. “You have all kinds of issues arising, and with each one you need to take a careful look and decide whether you have problem; if so, is it insurmountable or can you economically fix it?”
To illustrate how diverse these problems can be, Bonderman touches on a variety of social and environmental challenges TPG has addressed in its vast investment portfolio over the years: working with fast-food chain Burger King to create a sustainable disposal process for oil, fatty acids and other residue; enabling plastic bag manufacturer Hilex Poly to overhaul its recycling systems so that its products could remain an environmentally viable alternative to paper; helping casino operator Caesars minimise its energy consumption (and therefore its electricity bill), and so forth.
Addressing these kinds of portfolio scenarios is as much an exercise in risk removal as it is a potential value creation opportunity: “The point is not to walk away every time you discover an ESG problem. It’s like any other thing you consider: if you think you can work with the environmental community and get something done, and other guys can’t because they’re not sensitive or they don’t care, or because you have some long-term understanding, that constitutes competitive advantage – no different from having a lower cost of capital or a better management team. This isn’t box ticking – it’s part of the process.”
WHAT NOT TO DO
Bonderman admits that quantifying ESG impact in financial terms isn’t always easy or even possible. He also insists that this doesn’t reduce the importance of solving the issue: “Of course the most compelling cases are deals where you can do the right thing and it adds to your bottom line. The more difficult ones are where it doesn’t, or it’s not measureable, but you just have to navigate it the best you can. If you’re J. Crew [a TPG-owned US clothing retailer] dealing with a Sri Lankan supplier making your garments and you’re required to adhere to standards around no-child labour, you’re not going to employ any 10-year olds no matter what the cost differential is. You’re just not.”
And the reason you’re not isn’t simply because of what other people might say or think about you, even if they happen to be journalists: “The press has its point of view and they’ll say what they’re going to say. My perspective is: if you’re not prepared to have what you’re doing publicised, then you shouldn’t be doing it. It’s not because you’re afraid of the press. It’s because you don’t like what you’re doing.”
Alongside the TPG Sustainability Core Team led by Norton and Lowery, the firm uses its nearly 70-strong group of operating specialists worldwide to identify, address and monitor ESG-related risk/opportunity across the portfolio. Their focus begins at the pre-investment due diligence stage and then remains throughout the life cycle of the investment. It’s a resource-intensive and no doubt costly approach to portfolio management and ESG compliance, but then TPG can afford it: according to the 2013 edition of Private Equity International’s proprietary PEI300 ranking, it remains the world’s best-capitalised private equity firm, with more than $35 billion raised in the past five years. The firm’s website details more than 250 investments from a multitude of funds.
If you work at TPG, you’re obviously expected to operate within, and contribute towards, the culture that strives for excellence in ESG: “Everybody knows what the principles are. Some people might be better at applying them than others, but you’d better be good enough, or you’re going to have to find work elsewhere.”
Bonderman is equally adamant that private equity’s ability to bring about operational improvements in the businesses it backs, be it improvements in the ESG context or in any other area, is not a nice-to-have.
He thinks firms that do not invest in their own infrastructure to build the requisite skill-sets are, in effect, putting their franchises at risk. He’s quick to assert that with a few notable exceptions including CD&R, Bain Capital and KKR, few GPs have worked to hone their operational know-how the way TPG has. And he also predicts that to not have done it will turn out to have been a mistake. Asked for a piece of advice to any groups still primarily focused on financial engineering and restructuring, he delivers it with characteristic bluntness: “My advice is you’re not going to be around for much longer.”
With this the conversation begins to open up and extend into other topics that preoccupy the industry – including, necessarily, TPG. With a globe-spanning network of currently 17 offices, the firm is looking for opportunities in every region. Needless to say, Bonderman has strong opinions on all of them: “As an investment strategy, we don’t think it’s a brilliant idea to only invest in one area.”
That’s not to say he’s equally positive about all of them. Take Europe, which he believes will be on the ropes for years to come. Even though the prospect of the euro collapsing was oversold in his view – “we’ve always said the euro would stay intact” – there are huge, and fundamentally unresolved issues holding Europe back. “The only good thing you can say about Europe is that nothing bad lasts forever – although Europe will give ‘forever’ a run for its money,” he deadpans.
Warming to the theme, Bonderman anchors Europe’s inability to tackle its structural problems in its citizens’ lack of interest in economic growth. “Europeans in their heart of hearts don’t care about growth. The US, Indonesia and China are fighting it out to see if they can make the pie bigger; the Germans and the French are fighting to see who gets the bigger slice, but the pie isn’t getting bigger. Life will get better, because it always does, and Europe will recover eventually, but it’s going to take a long time.”
In the US, by contrast, the difficulty facing investors now is that so many of them have seen and continue to see it as a safe haven, which has resulted in strong capital inflows, inflating asset prices and an abundance of cheap funding. “You have to be careful if you want to obtain the kind of returns you’re meant to be able to provide.”
CHINA, INDONESIA, JAPAN
In Asia, where TPG was a prime mover among Western firms and, according to market sources, it is currently attempting to raise a new pan-regional fund, different markets function in very different ways. How TPG tackles these varied opportunities, Bonderman argues, depends on the nature and scale of the market in question, and also the availability of local talent that TPG knows well and vice versa.
In China for instance, where it has been active since 1994, the firm now has a large permanent presence with offices in Beijing, Chongqing, Hong Kong and Shanghai.
In Indonesia on the other hand, it has effectively replicated the joint venture strategy it had used for its first foray into Asia back in the mid-1990s, when it partnered with Blum Capital and Acon Investments to form Newbridge Capital, a platform that was later integrated into TPG. Today, the firm is in a similar joint venture with Indonesian firm Northstar Pacific Partners, which in May made seven times money from selling a stake in local bank BTPN to a Japanese trade buyer.
And in some cases like Japan, a country about which Bonderman previously has spoken disparagingly, TPG has invested and will continue to invest very selectively.
In terms of sectors, TPG remains a generalist, with expertise in areas including healthcare, retail and consumer products, financial services, industrial, energy, media and transportation. It is organised around a number of dedicated ‘platforms’ including TPG Capital, its late-stage private equity business; TPG Growth for smaller buyouts and mid-market minority investments; TPG Alternative & Renewable Technologies; TPG Opportunities Partners, a distressed business; and also a specialist lending arm. TPG Biotech, TPG Real Estate and TPG Asia complement the firm’s business lines.
Inevitably, some of the firm’s ventures have been more successful than others. One which had looked promising in the wake of the Lehman Brothers bankruptcy was to make investments in financial companies from a dedicated sector fund. Asked if this is still a priority, Bonderman says the financial services opportunity of four years ago has subsided, and in any case was never enormous to begin with: “There turned out to be much less opportunity than people thought there would be – for the obvious reason that governments haven’t forced banks to repair themselves.”
Among the investments TPG did make in the sector during the crisis was Washington Mutual: in 2008, the firm led a $7 billion capital injection into the stricken lender, committing some $2 billion of its own capital plus a large co-investment from LPs. When WaMu’s share price collapsed later following a $16 billion run on the bank, the syndicate was forced to relinquish control of the business to the Federal Deposit Insurance Company (FDIC). Its investment was wiped out, despite TPG’s protestations that it would still be able to turn the bank around and should have been allowed to try.
Has the WaMu experience made Bonderman more cautious about investing in financial businesses? “It’s certainly made me be very cautious whenever [former FDIC chairman] Sheila Bair is in the room,” comes the reply, suggesting Bonderman is still of the view that things could have been very different had certain government counterparties handled the situation differently.
WHAT NEXT FOR PRIVATE EQUITY?
So what does Bonderman think lies ahead for private equity? There are plenty of issues for the industry to deal with in the coming years, he says.
One is the ongoing debate around the type of ownership structure deemed most appropriate for private equity firms. Unlike rivals such as Apollo, Blackstone, Carlyle and KKR, whose management companies are publicly listed, TPG is still privately owned. Bonderman neither confirms nor denies any ambition to take his own business public one day.
“The jury is out on this, but five years from now it won’t be. It will either turn out that being public hurts your ability to raise capital, in which case we’ll see that the current listed groups will stay listed and all the others will stay private. Or it will prove a good way to raise capital, in which case everyone else will go public, same as we saw in the investment banking industry.”
Another ongoing development he predicts will accelerate is the proliferation of specialised private equity products – regional or sector-specific funds, separate accounts and the like. “Some of this will be cyclical, but some won’t be. It just won’t be one-size-fits-all anymore. And we’ll also see a lot of firms failing.”
Does this mean TPG won’t be raising global funds in the future? Bonderman says it will – but it may add other, complementary vehicles too. “We already have an Asian fund. Should we have another one for Latin America, or the emerging markets? The industry has to work through these issues. And LPs’ views on this do change from time to time.”
Asked about succession planning, Bonderman replies that the firm does it, and that there are plenty of talented people in the organisation in their late 30s, 40s and early 50s that have been with the firm for 10 or 20 years. “At some point those guys will be running the place – and I won’t be.”
For the time being, however, Bonderman remains fully engaged. The man who started doing buyouts in the 1980s whilst working for Texan billionaire Robert Bass, and with then-partner Jim Coulter went on to build TPG, sticks to a packed schedule and continues to travel the world.
In addition to leading the firm through the current cycle, his focus is on a variety of matters – including ESG. The day after our meeting, he tells the PEI/UN PRI Responsible Investment Forum that for private equity the sustainability challenge is going away no less than it is for any other industry: “GPs are more aware of these issues than even five, six years ago. And I can’t imagine anyone being insensitive to this.”
Because for outcome-oriented general partners, there are just too many reasons not to be.