Private equity specialist warns of several mergers ahead as downturn bites

By Ian Fraser

 Sunday Herald

November 25th, 2001

VENTURE capitalists must reinvent themselves if they are to continue to capture investors’ imagination in the wake of the fall- out from the dot.com crash, a leading private equity specialist has claimed.

Jonny Maxwell, who last week delivered a keynote address at the European Private Equity conference in Edinburgh’s Crowne Plaza Hotel, attended by delegates from around the UK, believed “people lost the plot” during the rush to cash in on the boom in technology businesses.

“With internet ventures, all you had was a source code, a concept and a lot of hot air,” he said. “Yet too many private equity investors jumped on the bandwagon. They have now been left with wardrobes full of the Emperor’s new clothes.”

Maxwell said the consequence will be forced marriages between private equity houses, which Maxwell termed “cannibalization”. He also said there will be continuing write-downs in venture funds, a reduced flow of new money – particularly from the US – a slower pace of investment, and, of course, a dearth of initial public offerings (IPOs).

Many private equity firms in this position are now vulnerable, as investors, unhappy at seeing the value of their investments plunge by 95%, have recently been withholding their management fees.

During the conference, sponsored by Scottish Financial Enterprise, there was a considerable amount of soul-searching over what had happened to sanity levels in this niche of the financial services industry, especially when it came to crazy valuations being placed by venture capitalists on internet companies in 1998-2000.

Maxwell, who runs both funds of funds and private equity investment trusts at Standard Life Investments, highlighted the fact that many private equity houses are now facing serious succession issues. This is because the VCs who founded them have retired or are in semi-retirement. “A lot of them have made shed loads of cash and retired to Bermuda,” said Maxwell.

Steve Scott, director of Glasgow-based Penta Capital, was candid about the state of the sector. “This may not be a popular view in our industry,” he said, “but the current fee structure [a 2% management fee plus 20% of any upside] is deeply unattractive to many investors There is real fee pressure on people like ourselves.”

Scott added that to attract more institutional money, the private equity industry would have to become more transparent by, for example, the benchmarking of funds. He believes investment trusts and funds of funds will become increasingly attractive holding vehicles. “Funds of funds will explode, but they will have to start differentiating themselves.”

Scott said that exit routes – the means by which VCs recoup their money – will change dramatically. “IPOs are out the window for our industry. A lot more exits will in future be financed by refinancing or secondary buyouts.”

Most private equity specialists attending the conference – organised by Websters Communications – now see mainland Europe as their stamping ground. This is partly because of an over-subscribed UK market and because management buyouts and similar deals are still in their infancy in most of Europe. Only £22 billion of private equity was invested in Europe last year compared to £70bn in the US.

But David Giffin, director of Royal Bank Private Equity, wondered how many VCs are really prepared to overcome cultural hurdles. He suggested investing in Germany and France could be far riskier than it seems.

Giffin asked: “How many of you have direct experience of doing deals in Europe?” No hands went up. “Do we really understand the risks and how to assess those risks? Did we understand the risks with dot.coms?”

He said one way to prevent mishaps is to form alliances, joint ventures and networks. Royal Bank has access to a European network through its 1989 alliance with Santander Central Hispano.

Maxwell said some positive benefits have stemmed from the irrational exuberance of the dot.com era. “If nothing else, it highlighted and increased awareness of this asset class.”

He referred to the Myners report into institutional investment which has urged UK pension schemes to give greater support to the grassroots economy by putting more money into private equity investments.

Currently only 1% of British pension-fund investment goes into private equity, compared with 5% in the United States. These figures led some of the speakers to predict that a wall of money will now flood into their sector as wealthy individuals and pension funds seek to spread their risk, given that the “cult of the equity” is dead.

Ray Soudah, founder of Zurich-based Millenium- Associates, said: “Private equity is going to explode by a factor of about five times as both institutional and private investors seek alternative investment products.”

But Soudah said the biggest challenge facing the sector, which remains a cottage industry being both highly fragmented and privately owned, was to mature quickly enough to handle the surge in demand.

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Posted by Ian Fraser on Nov 25 2001. Filed under Article Library. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry