Analysis | Why Is This Fund Executive Calling Private Equity a Ponzi?

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Is private equity’s stellar performance too good to be true? As the global stock market slump forces mutual funds to mark their holdings to market, some are getting vocal in their skepticism of private markets.  

Speaking to journalists last week, Vincent Mortier, chief investment officer of Amundi SA, Europe’s largest asset manager, questioned how private equity firms can keep their performance aloft even as the market for initial public offerings slumps:

The vast majority of deals are currently done between private equity players… One private equity player will sell to another one who is happy to pay a high price because they have attached a lot of investors.

When you know you are able to exit your stake to another private equity house for multiple of, let’s say, 20, 25 or 30 times earnings, of course you won’t mark down your book… That’s why I’m talking about a Ponzi because it’s a circular thing.

Intuitively, this makes sense. Last year, with a vibrant US stock market, private equity firms hit an exit frenzy, reaping billions for their investors. But with the IPO market in a drought and strategic buyers growing more cautious, PE firms are running out of options. These days, to exit, they will have to sell their portfolio companies to each other.

A few recent deals may have caught Mortier’s eye. In April, KKR & Co. agreed to buy Barracuda Networks Inc. from tech-focused Thoma Bravo LLC, in a deal that reportedly valued the cybersecurity firm at about $4 billion. Thoma Bravo can probably book a handsome profit — it took Barracuda private four years ago for only $1.3 billion.

Meanwhile, in the last two years, private equity firms have been avid fundraisers. For instance, KKR in April closed a record $19 billion North America fund, more than $5 billion larger than the previous 2017 fund. With more than $1 trillion of dry powder globally, cash-rich PE firms have plenty of room to buy stakes off each other. Thoma Bravo, for instance, this week lowered the $10.7 billion offer it made to enterprise-software maker Anaplan Inc.

But looking at recent deal flows, Mortier’s comments come across more like a warning than a reflection of reality. While about two-thirds of the exits in the first quarter were transactions among PE firms, their actual value of $43 billion is by no means extraordinary by historical standards. The same conclusion holds if we look at deal counts instead. 

In other words, the conditions are ripe for what Mortier called a “Ponzi” scheme in the PE industry. But so far, there’s not much evidence.

More likely, criticism from traditional asset managers reflects their envy that private equity firms seem to be winners in times good and bad. On a 1-, 3-, 5- and 10-year horizon, private equity has generated higher internal rates of return than public markets. 

Stock markets took note and rewarded private equity specialists accordingly. Shares of Blackstone Inc. and KKR have outperformed traditional money managers. such as Amundi. 

To be sure, there’s a lot of room for window-dressing in the PE world. For instance, it’s standard practice to use public-market peers to value unrealized investments, even though there’s no guarantee the PE-backed firms can fetch similar valuations.

And just like public-market investors, PE firms in recent years paid handsomely for their investments. In the first quarter, a median buyout was priced at 14.6 times EV/EBITDA, or the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization, versus 11.9 times four years earlier, according to PitchBook.

Nonetheless, this is the beauty of private equity. It provides investors haven from a bad stock market. With all that dry powder, it can also benefit from a bear market, by taking companies private and lowering its average cost of acquisition. Managers of mutual funds and hedge funds, who have to worry about investor redemptions, are in the wrong business.

More From This Writer and Others at Bloomberg Opinion:

• Tiger Global and the Perils of Crossover Hedge Funds: Shuli Ren

• KKR Wins by Treating Workers More Like Owners: Brooke Sutherland

• Private Equity Finds Another Steal in the U.K.: Chris Hughes

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. A former investment banker, she was a markets reporter for Barron’s. She is a CFA charterholder.

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