Robin Fuller from the Guernsey Investment Fund Association (GIFA) examines the trends being seen across Guernsey's private equity sector.
What trends have you seen in private equity deal making in Guernsey over the last 12-18 months? How would you describe activity levels?
Fuller: We have seen a high level of deal-making activity over the last 12 to 18 months and strong competition for the most attractive assets. Virtually all PE deals have competition putting the vendor in a strong position and making it a challenge for some PE managers to deploy capital. Managers are making every effort to source off-market transactions to ensure acquisitions at low multiples or looking for other methods to create value rather than pure buy and hold. GPs have been focused on returning cash to investors when there are favourable valuations and there has been significant activity around exiting historical portfolios. Importantly, these exits have been achieved through a range of avenues, trade sales, secondaries and public listings.
Which key sectors do PE firms seem to be targeting in Guernsey, and why?
Fuller: The Guernsey funds industry supports PE firms operating on both a regional and a global basis and across a broad range of sectors. Sector focus is therefore dependent on the firm but there are a number of interesting themes – in technology, for example, with companies addressing the big data challenge and cloud based technologies. There has been further PE investment and interest into the financial services space and clearly as a leading global centre for financial services that's a particularly interesting trend for the island.
Are banks demonstrating an appetite to provide financing for leveraged buyouts? What equity contributions are PE firms generally required to make towards transaction values?
Fuller: Financing is readily available in this market, from banks and also from non-traditional debt providers. Equity contributions can vary significantly but 30 to 50 percent equity is not unusual. Managers often look to use vendor financing or some form of deferred consideration on top to improve returns.
Could you outline the most significant legal and regulatory developments facing the private equity industry? In your opinion, how will they shape the asset class in the long term?
Fuller: Regulation is continuing to become more complex, with new legislation and regulation being implemented in the EU, the US and internationally. Significant regulatory initiatives like AIFMD, BEPS and Dodd-Frank will continue to have a considerable impact over the long term and one of the key challenges now is to address and manage the impact of these changes from an operational standpoint. At the same time, measures which are perhaps less directed at the industry, such as those focusing on cross-border ownership and taxation, are converging to create an ever greater administrative burden. The impact of these developments will be an increase in operating costs for firms, from an increase in the number of non-investment professionals needed to address the increasing requirements or an increase in fees paid to external advisers and consultants.
What methods have you seen PE firms using to build value across their portfolios, reduce risks and improve returns?
Fuller: PE firms continue to use a broad range of value creation levers to build value across their portfolios. Some firms may focus on growth opportunities while others may take a more specialised approach to generating alpha returns. Strategies include strengthening management, developing through capital expenditure, building through mergers and acquisitions, and lowering the cost of capital to create extra upside. Portfolio businesses in PE firms have also been trying to reduce risk and volatility of returns through pursing longer-dated contracts.
How has the relationship between general partners (GPs) and limited partners (LPs) evolved in recent years, and what effect is this having on the fundraising process?
Fuller: The traditional blind pool private equity fund remains the main product of the industry but LPs are increasingly exploring additional or alternative ways of deploying capital. This includes putting more money into separate accounts, co-investments, joint ventures and directs. In addition, there is an imbalance between the GP-LP relationship as the number of GPs raising new funds exceeds LPs' ability to commit. With this, GPs need to focus on what LPs seek – returns, investment ideas and alignment of incentives on investments. Large GPs have remained attractive to LPs because of their ability to take large capital and provide consistent returns. Smaller GPs have, in many cases, become more specialised with a smaller number of close LP relationships. In both cases GPs need to demonstrate flexibility, transparency and 'skin in the game'.
Looking ahead, what are your predictions for the key opportunities and challenges that are likely to face private equity firms over the coming months?
Fuller: Looking ahead, PE firms face challenges from both economic and geopolitical factors. The tapering of quantitative easing programmes and the raising of interest rates will lead to reduced liquidity in the equity markets, lower exit valuations and beta returns, together with an increase in the cost of capital. Geopolitical challenges include the prospects of 'Brexit' and elections across Europe. However, the industry has demonstrated that, even in challenging economic cycles it can produce a strong return for investors. The challenge for firms will be to continue to deliver premium returns throughout the cycle while maintaining discipline around price and investment focus.
An original version of this article was published by Financier Worldwide, December 2015.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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