Another strong year predicted as cross-border private equity activity hits record high value in 2018
1,858 cross-border PE deals, worth a total of US$456 billion, were recorded in 2018, the highest annual volume and value figures on record
Total deal value rose 3.6% over 2018
Cross-border primary buyout deals in 2018 totaled US$222 billion globally, a 30% increase year-on-year
Hogan Lovells Partner Matthias Jaletzke shares his insights on cross-border private equity activity.
PE firms are sitting on over US$2 trillion in dry powder and the increased capital is driving up valuations and competition for good assets. Has this led firms to increasingly consider cross-border deals?
Matthias Jaletzke: If you look at the history of private equity (PE) in Europe, and to some extent also in the United States, it has always been cross-border.
If you look at different segments in PE, the really big funds that sit in the United States – Hellman & Friedman, Blackstone, KKR, Apollo, Bain – have funds with double-digit billion dollar or euro amounts, and they have been doing deals outside the United States for 15 to 20 years. Then you have large UK funds, such as Apax Partners, Cinven, CVC, or Permira, that have fund sizes between US$3 billion and US$10 billion. They were already doing deals across Europe in the late 1990s.
There has been a rise in cross-border PE activity, but it has always been a feature of the sector.
Are PE firms increasingly looking at sectors they previously would have avoided?
Jaletzke: Health care is one sector that PE funds wouldn’t have looked at ten years ago. In the last three to five years, we have seen a lot of transactions in the nursing home sector from mid-size firms like Carlyle, EQT, and Nordic Capital. This has to do with aging populations and the stable cash flows these businesses provide. We have also seen a couple of firms invest in hospitals and clinics. Again, that is something that was unknown a decade ago.
Additionally, the aerospace, defense, and government services (ADG) sector has become increasingly attractive to funds. (See our ADG Market Insight for more info.)
On the other hand, there are sectors that are less popular than they used to be. PE is pretty skeptical about the automotive industry, for instance. The industry is changing from traditional combustion engines to electro-mobility and while that takes investment, the future has become less certain and it is not clear how quickly things will change.
What are the challenges facing PE firms when attempting to exit large investments?
Jaletzke: Inherently, in really big deals, the number of potential buyers are limited. And if you look at how volatile the stock markets have been in the last 24 months, it hasn’t necessarily been a favorable time for IPO-based exits either. The biggest cross-border PE deal of Q1 was the US$6.4 billion take-private of Scout Holding AG, which is interesting, because Hellman & Friedman had IPO'd Scout not that long ago. But, given the downturn in the public market, it was relatively good timing to re-acquire. Scout is an internet/e-commerce company, so everyone expects it to have a good future. When the stock markets go up, there is likely an arbitrage opportunity to exit via the stock exchange again.
Speaking of Scout, as you mention, it was taken private by a consortium made up of Hellman & Friedman and Blackstone. Are these types of club deals becoming increasingly common? What are some of the challenges when PE firms do these kind of deals?
Jaletzke: When it comes to club deals, you have to be sure that the philosophy of the club members is concurrent and harmonized around management and how to develop the firm.
In most of the club deals that I have seen, participants thought they were on the same page – but what happens if the company comes into a crisis? If the company does not perform according to expectations, what does that mean in terms of exit strategy and management strategy? And here we've seen a couple of situations where participants left the consortium and were bought out by other participants. So, there are different aspects that make club deals difficult to execute through the exit.
I predict that we will see them on-and-off again for really large deals. Club deals tend to come in and out of fashion in the PE world. For instance, in the 2000s, there were many large firms taken over by consortia. Then, after the Lehman crisis, club deals subsided for a while, and now we are seeing some large club deals again, so it's a bit cyclical. I do not think that, as a general notion, club deals are more popular than they were in the past.
How are PE firms responding to the challenge of increased competition from strategics and rivals for the strongest assets?
Jaletzke: Firms have become much more operational than they used to be. Before the Lehman crisis, PE was, in some respects, about financial engineering, and getting your finances straight, before executing a decent exit a couple of years later.
More recently, all of the big PE funds have so-called “operating partners” and are more deeply involved in the strategy of the companies that they are buying. There are some firms where the investment is done by investment partners, and then the asset changes hands and is handled by the operating partners, who are often former executives of large companies with a lot of industry experience. This is something that has changed in the last five to seven years and it is certainly a method of trying to improve the handling of the asset and the success rate with the asset.
One of the main themes that has emerged recently in cross-border M&A is increased protectionism. How does it affect PE?
Jaletzke: This is a multi-faceted issue. Recently, for many asset classes, Chinese buyers have effectively been taken off the market because of CFIUS approvals. Moreover, China has tightened foreign exchange controls, and with the trade war with the United States, it is very difficult for a Chinese buyer to invest in anything that comes close to being considered national security in the United States. There are only a few PE firms that predominantly use Chinese or Middle Eastern funding, but they might come under increased scrutiny.
Conversely, this may be positive for the large U.S. PE funds. Most of the investors in U.S. PE funds like Hellman & Friedman, Blackstone, and Apollo, are big U.S. institutions like CalPERS. For these funds, it may actually be somewhat of an advantage. On the other hand, it could potentially be an issue for future exits. Certainly in recent years, people were anticipating that China would be an exit route. That route does not exist in the same way now. We can expect, however, that trade hostilities will be resolved one way or the other and, therefore, Chinese buyers may come back in the long term.
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