Home Hedge Funds What does $1.8trn of private equity ‘dry powder’ mean for public markets? 

What does $1.8trn of private equity ‘dry powder’ mean for public markets? 

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The recent cash bonanza in private markets could lead to more take-privates of publicly listed companies, as private equity and infrastructure funds seek to create value in evergreen assets.   

Private-equity funds in particular are awash with cash, with levels of unspent money in the asset class hitting new record highs of approximately $1.8 trillion this year, according to the latest estimates from research company Preqin. 

Some of that money is now filtering through to the public markets, against a backdrop of rising interest rates that could make private equity’s modus operandi, the management buyout, more expensive.   

On Monday, San Francisco-based hedge fund Inclusive Capital Partners made a £1.5 billion offer to privatise homebuilder Countryside Partnerships PLC (LSE:CSP) showing property and domestic transport have rich pickings for private investors.  

Following the bid, Countryside’s shares shot up 20% on Monday morning to 288.8p.  

This month, private investors swooped to buy two publicly listed transport operators, Stagecoach Group PLC and FirstGroup PLC which will subsequently delist from the London Stock Exchange.  

While international flight travel declined following the Covid-19 pandemic, domestic travel has bounced back, making the sector increasingly attractive to buyers.   

Stagecoach’s founder Brian Souter announced this week that the bus and coach operator will delist from by 27 June.   

FirstGroup’s stocks meanwhile jumped on the news that private-equity firm I Squared Capital made a bid for the company valuing it at £1.23bn, following ongoing tension with activist investors that effectively ousted its chief executive Matthew Gregory last July.   

Its shares climbed nearly 19% last week t 135.3p following the takeover bid.   

Other transport companies that could similarly become targets for private equity include Go-Ahead Group PLC (LSE:GOG), which has seen its share price rise 51% in the last six months, to 1,030p on Friday.   

National Express Group PLC (LSE:NEX), which has a market cap of about £1.7bn, may also become a possible target for private investors, with its earnings forecast to grow this year as a result of a recent change in strategy, according to analysts.   

The company said in its annual results that it is aiming to reposition itself in the shared mobility space, a move expected to generate £1bn of revenue growth in the next five years (through to 2027).  

The imminent takeover of Stagecoach means National Express Group will no longer combine with the company, it said in a statement.  

Other domestic transport operators that could become attractive assets for private equity include Redde Northgate PLC (LSE:REDD), a car rental service operating in the UK and Europe.  

Predicted revenue growth at the company this year could help redress the recent vacillation in its share price despite its rebound since the pandemic.  

The car rental business forecast 12% growth in its turnover in 2022 as it expects demand for used vehicles to grow.   

Private equity works for itself

Private-equity firms historically have a poor reputation for creating value for shareholders.   

This can be partly blamed on the high amount of leverage (debt to assets) used in management buyouts, which can leave target companies saddled with borrowings on their balance sheet and vulnerable to interest-rate rises.   

The retail space, for example, suffered a wave of bankruptcies, ten years on from the financial crisis, among companies that were overleveraged during the heady days of the market collapse in 2008.   

Private-equity firms have developed a reputation, justified or not, for stripping management teams and leaving little value left for public investors.   

However, the recent strong performance of Pets at Home Group PLC (LSE:PETS), which was listed by private-equity firm Bridgepoint in 2014, may yet be proof that the asset class’s reputation of failing to generate sustainable value should be taken with some salt if not completely re-evaluated.   

Pets at Home is a private equity-to-public markets success story in a wave of mooted offerings that haven’t come to fruition in recent years, as firms sat on their hands during times of market turbulence.   

The pet care business recently reported robust earnings, pleasing public market investors and driving a 17% increase in its share price.   

The company said it grew turnover by 15.3% to approximately £1.32bn in the year through to March 31, boosting its pre-tax profit.  

One swallow a summer? 

Its recent growth suggests that the reputation private equity has long had for failing to transition companies to the public markets might yet be unfair.   

Indeed, Allianz reported in October that the IPO market increased to record heights last year, driven by private-equity money.   

It said private equity “turbocharged” public listings, creating significant value in the small-cap space when compared to other listings.   

The financial services company said that in principle, an IPO backed by a private-equity firm should “outperform” other listings due to the preliminary research that goes into such investment decisions.   

Private equity-backed IPOs should outperform so-called ‘naked’ listings, but a lot depends on the firm and asset class’s own performance, according to Allianz. 

“The acceleration in the relative performance of a certain sector versus the broad market tends to trigger a wave of new IPOs within the thriving sector as companies ready to go public take the window of opportunity to jump into the market,” Allianz said.   

It said private equity-backed companies “have the upper hand” in the small-cap space of $50mln to $500mln, outperforming naked IPOs by about 8%, but typically underperform in the mid-cap space. 

If the asset class can get comfortable with the exit value offered by the public markets again, firms that choose to spend their war chest in the small to mid-cap space may create a pipeline of future shareholding opportunities through IPO listings.  

The Covid pandemic, lockdowns in China, high energy prices, Russia’s war on Ukraine and associated food shortages, high inflation and the cost-of-living crisis all rocked public market stocks.  

Private-equity funds are notoriously conservative and risk-averse compared to venture, activist or public investors, and will typically wait for an opportune moment to exit a business through a public-market listing when it can achieve a bigger market capitalisation.     

Likewise, for publicly listed companies that have struggled to lift their share price due to pandemic-related pressure, a privatisation could offer an opportunity for behind-the-scenes growth. 

Private-equity firms usually recommend that public companies delist from the public markets to give them an opportunity to invest and grow without public share-price pressure.  

This happens both in the case of a management buyout, where the firm keeps the current management in place following an acquisition, and at times when it parachutes in a new management team.  

The rising level of unspent capital held by private-equity firms, known as ‘dry powder’, nevertheless remains a double-edged sword for the asset class.   

The rising cost of capital has put pressure on the illiquidity premium that usually makes the asset class so attractive to investors. 

Burgeoning dry powder has decreased returns to investors and bigger fund commitments typically come with higher investor fees, which are usually calculated as a percentage of total fund capital.   

While inflation is driving up underlying business costs and post-pandemic operational spending, rising interest rates are pushing up the cost of debt typically used to finance management buyouts.   

The Bank of England put up the bank rate to 1% in May, up from 0.5% in February. 

The backdrop of rising interest could ultimately make staying or listing on the public markets a potentially more attractive option to many mid-cap companies than a buyout, as the debt required for management buyouts becomes more expensive for businesses in the long term, but the temptation of high cash bids and continuing pandemic pressure on stocks may be too great. 

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