Is the appetite for private equity co-investment a healthy one?
June 2015 | FEATURE | PRIVATE EQUITY
Financier Worldwide Magazine
Within the rarefied world of private equity investment, there is consensus that a large appetite currently exists among GPs and LPs for indulging in some co-investment activity.
LPs, it is said, are particularly keen, as they may wish to reduce costs and risks, temper the effects of the J-curve, build their market exposure and achieve greater control over the risk profile of their investment portfolios.
By way of illustration, EY’s ‘2015 Global Private Equity Survey’ highlighted the fact that 69 percent of private equity firms are currently offering co-investment opportunities. And furthermore, if one was to consider the number of co-investment funds raised in recent years, the obvious conclusion is that the trend is going to continue for the foreseeable future.
Yet not everyone is convinced of the long-term validity of co-investment. Tim Jones, chief executive and deputy chief investment officer at Coller Capital, told delegates at the EVCA Investment Forum in Geneva in March 2015 that, in his view, “co-investment is not doing the industry any good”.
So is Mr Jones greatly mistaken, or is he correct and the private equity co-investment trend is destined to be relatively short-lived?
Recent private equity co-investment trends
First of all, we must consider the factors that have been driving the recent popularity of co-investment opportunities and, in turn, gauge their durability. “A more competitive private equity landscape has prompted an increase in co-investment opportunities being offered on the market today,” says Maryna Irkliyenko, Mergermarket’s EMEA Private Equity correspondent. “With private equity buyouts in Europe showing signs of slipping early this year – Q1 saw €17.3bn worth of PE buyouts conducted over more than 200 deals compared to 271 deals valued at €18.85bn 12 months earlier – sponsors are looking for alternative ways to encourage fundraising. Co-investment offers such a window for investors. The benefit of lower costs and potentially higher returns for investors has similarly seen the trend of co-investment steadily rise.”
Antoine Dréan, chief executive of Palico, told FT.com that, presently, around 20 percent of all private equity deals involve co-investment. In pre-financial crisis days, the figure was 5 percent.
One criticism levelled at the burgeoning trend for private equity co-investment is the possibility that LPs are forcing some GPs to enter into ever-larger transactions that they are not accustomed to dealing with – a scenario that could damage the industry. Cutting to the chase, what can we assume the potential repercussions of this transaction trend to be on the co-investment dynamic?
“Private equity deal sizes have risen – a 26 percent drop in deal volume versus just an 8 percent slip in value year-on-year for the first quarter of 2015 demonstrates that private equity firms are willing to pay higher prices for quality assets,” observes Ms Irkliyenko. “A more sophisticated investor base, seeking greater profits after several years of low-yield returns, may not be directly responsible for GPs chasing larger transactions, but it is likely to have been a contributing factor. Another trend of private equity firms raising funds to specifically hunt and finance specific deals could be seen as evidence that their appetite for larger deals is on the rise.”
Perhaps providing a modicum of reassurance for GPs is the private equity co-investment transparency data contained in the EY Survey, which shows that 73 percent of co-investment sponsors provide quarterly reporting, audited financial statements and valuation assumptions and inputs, while 27 percent provide audited financial statements only. In terms of whether private equity firms are fully independent or fully reliant on sponsors’ co-investment values, 40 percent indicated the latter and 60 percent said the former.
Despite the positive outlook, there is clearly plenty of room for debate over whether the current co-investment trend is a good thing for the private equity industry and, going forward, if it is truly sustainable in the short, medium and long-term.
Ms Irkliyenko’s view is positive. “Co-investment deals help bind relationships between LPs and GPs. Such goodwill can be used to help secure commitments for future funds. With more acquisition opportunities being offered as M&A in general rises year-on-year, competition among private equities has similarly grown. Co-investment is one way of helping swell the amount a private equity can pay for an asset, but this can consequently lead to competitive auctions among sponsors leading to increasingly higher values being paid. How this affects eventual exit multiples and whether the higher rates of return that have been experienced over the past few years will be affected, remains to be seen,” she says.
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