An “obsession with growth” has deterred private equity funds away from the real drivers of value in their portfolio companies, co-founder of Pacific Equity Partners, Tim Sims, said on a panel at the PEI Asia Forum 2014 in Hong Kong this week.
Delegates heard from the Australia-based GP, “Growth per se gives you no investment return. What you pay for [that] growth is what gives you your investment return.”
Sims explained that while growth can help soften blows when firms make mistakes with their portfolio companies, during periods of hampered growth, positive macroeconomic indicators will not be there to save the company.
“Growth per se is irrelevant,” Sims continued. “It is easier on the way up because if you make mistakes your growth holds you [up after] your mistakes. If you make mistakes on the way down, they are very unforgiving.”
After a decade of stellar growth enjoyed by GPs in markets like China and India, GDP growth has now slowed and private equity firms are readjusting their strategies to fit what is considered a new normal by many industry players.
Increasingly, firms are focusing on operational improvements and value added propositions when investing in businesses.
Fellow panelist Fred Hu, chairman of Primavera Capital Group, went on to describe China’s former double digit growth as an environment where it was difficult for private equity funds to find value.
“That kind of growth model wasn’t necessarily the best friend of private equity investors,” Hu said, explaining that the country was then driven by exports, government investment and credit expansion. “It was very hard for private equity to find or create value in that kind of high growth environment.”
However, he explained that as growth and exports have declined, China has become more reliant on domestic consumption, with sectors like healthcare and e-commerce growing at up to 30 percent and 80 percent respectively.
Dhanpal Jhaveri, chief executive at Everstone Capital Partners, echoed the same sentiment of India, offering that close to 50 percent of its GDP was driven by domestic consumption, while the 25 percent reliant on exports was to balance the deficit due to its partial reliance on imports.
While GPs from emerging Asia appeared more concerned about growth than Sims, who operates in a more developed private equity market, all agreed the most important thing was to focus on operational value add.
Hu explained that discipline was the main difference when operating in a slow growth environment versus a high growth market with regards to maintaining costs.
“You really, really have to be very disciplined about every penny you commit on the operations side.”
Sims added, “We as a private equity community should be alert to these factors and feel a responsibility to make sure that we know what drives our business returns – it is not growth. It is the unique insight into what you [can] add in future value to the thing you buy and that the day you buy you’re paying more than what anybody else thinks it is worth.”