Understanding Why We Like Buyouts
The beauty of making control investments
1. Buyouts emphasise control and have generated higher returns, outperforming other asset classes globally
Globally, Buyouts have historically performed better than other equity asset classes, as well as most other private equity asset classes regardless of economic expansion or downturns such as the Global Financial Crisis, according to analysis conducted by Preqin.
On top of operational improvements, the use of debt to finance part of the acquisition cost enhances the return on equity. A study by the Danish Venture Capital Association shows that leverage makes up c. 35% of all value created and enhances performance by 8%-14% IRR or c. 0.9x MoIC1. This means an unleveraged investment that returned 19% IRR and 2.0x MoIC over 5 years can potentially return 30% and 2.9x MoIC on a leveraged basis. The effect of leverage is also the largest contributor to returns and adds to value as much as EBITDA enhancement initiatives such as revenue growth or cost reduction.
2. Pure control regime enables Buyout funds to unlock value effectively
With control, buyout firms are in a better position to drive value creation initiatives, grow companies both organically and through M&A, re-organise them around core competencies and assets and re-finance themselves to execute various strategies such as roll-up plays, regionalisation and productivity enhancements. It also allows them to structure and control their exit strategies in terms of transaction structures, terms, timings and routes, so as to maximize investment upside compared to minority investors who typically do not have the same ability to unlock value, especially if they are not able to exit via an IPO.
For example, Blackstone's US$20b investment in Hilton took a big hit during the Global Financial Crisis, but the firm was able to restructure and reduce the company's debt from US$20b to US$16b in response. By 2013, the company was able to go for an IPO giving Blackstone the second largest profit (US$8.5b) of any private equity deal in history. Similarly, Apollo Global Management also used control to restructure Realogy Holdings, a company they bought out in 2006 for US$8b. Apollo decisively reduced cost through streamlining Realogy’s workforce and restructuring debt to create efficiencies that boosted the company’s profit. Realogy subsequently went public in 2012 and doubled Apollo’s capital with a profit of US$1.3b.
Astute investors recognise that control oriented Buyouts are better prepared for an economic crisis and are therefore able to control risk better than other Private Equity asset classes.
3. Ability to take rapid decisive actions to mitigate unexpected events
Control provides superior downside protection by enabling buyout firms to rapidly respond to changing business conditions or unexpected market events such as macroeconomic shocks. The private equity experience during the AFC unveiled the vulnerability of minority stake private equity investments when the viability of many growth capital funds, which had focussed on taking pre-IPO minority stakes struggled to take decisive measures such as restructuring or exiting their investments, was severely tested. The crisis experience also led to the realisation of the strength of control investments, which became widely appreciated in 1999 when CVC, J.P. Morgan Partners and UBS Capital started making LBOs for the first time in Asia.
Within the Buyout space, the mid-market is the most attractive segment
While large Buyout transactions have dominated news in the market, there is a very attractive market gap to be exploited within the mid-market Buyout segment, which the Point Hope Group focuses its investments on most. The attractiveness of the mid-market segment is demonstrated in mature markets such as the US, where the mid-market makes up a significant proportion of deal volume, with deals less than US$500m in value making up 50% of total volume.
According to a survey conducted by Probitas, c. 60% of interviewed LPs indicated they would focus greater attention on US mid-market Buyouts, indicating strong LP interest in the mid-market space. The mid-market segment comprising of companies with enterprise values between US$25m and US$250m is under-research and under-intermediated, and therefore favours research-driven Private Equity firms which are able to uncover proprietary investments at more favourable entry multiples. Furthermore, there are greater value creation opportunities in mid-sized companies compared to larger companies.
Background on the Buyouts industry in Asia
In Asia, the Buyouts industry was birthed in the wake of the 1997 Financial Crisis which decimated many Private Equity funds in Asia as most of the predominantly minority investments took severe hits, leading to the realisation of the strengths of control investments.
Since then, Buyouts has become an increasingly important asset class in Asia with consistently superior returns compared to other asset classes globally, driven by the advantages conferred by control in being able to leverage, unlock value and manage investment exits.
Asia has also rapidly gained prominence as an attractive Buyout geography with strong growth potential underpinned by rising macroeconomic and demographic conditions, a well populated and undiscovered mid-market space, and yet a highly underpenetrated buyout market.
Due to the short history of Buyouts in Asia, there are currently less than 30 Buyout funds in the region, of which only a third are able to operate at a pan-Asian level, due to an acute shortage of skilled Buyout professionals having pan- Asian experience. The interplay of the attractiveness of the current Asian Buyout opportunity and the market gap in experienced pan-Asia Buyout funds particularly in the mid-market space provide a compelling case to take action in this space now.
The investment team at Point Hope Group have been active in private equity since 1997
An Original Thinking piece by Gerald Leong, Charles Kok and Daryl Tan
Ready to find out more?
Meet our Investment and Operating Partners