11 Mar 2019
The private equity industry swelled in size in the decade following the financial crisis as investors around the globe hunted for higher returns in a low interest rate world. Such a surge is sure to cause some concern, but far from getting too big for its boots, private equity is fast becoming pre-eminent in its access to high growth companies.
Private equity assets under management in Europe hit €640 billion at the end of 2017, according to Invest Europe data. That means that European private equity is about two-thirds larger than it was when the financial crisis hit and around 5.5 times the size it was in 2000, growth that broadly reflects industry expansion on the global stage. Private equity dry powder in Europe also reached an estimated all-time high of €145 billion at the end of 2017, a five-fold increase since the turn of the millennium. Moreover, the last five years have accounted for 34% of the roughly €1 trillion raised by funds in Europe over the last 25 years.
It’s only natural that investors ask questions. Is private equity getting too large? Do firms have too much capital and insufficient opportunities? These and many other topics are sure to be discussed when investors and managers meet at Invest Europe’s Investors’ Forum in Geneva on 27-28 March, 2019.
Yet, as private equity has expanded, so the world around it has changed. Most notably, the realm of public equities has shrunk substantially. Last year, at Carlyle, we conducted research into public company ownership. We found that private equity’s expansion doesn’t only mirror investors’ demands for better returns, but also reflects a radical shift in the form of investment capital that companies are seeking.
Our study focused on the US, but it’s a global trend with Europe following a similar trajectory. Between 1996 and 2018, the number of public companies halved from 7,322 to 3,671. The reason is a dearth of initial public offerings, with new listings in the US down by 75% since the late-1990s. Most companies now choose to go public much later in their life cycles, if at all.
So what’s driving companies away from public markets and towards private ownership? The appeal of long-term patient private capital and extensive operational expertise is as strong today as 20 years ago. But there are other significant factors at play too.
First of all, there’s speed and execution. No longer do public markets guarantee the fullest pricing. Capital markets efficiency means that private equity can make full and fair valuations, and guarantee that payment in one go. Entrepreneurs and company management avoid lengthy and distracting investor roadshows and may not have to settle for liquidity dribbling out over months or years through share sales.
Then there is the potential cost and risk associated with public markets. The public markets disclosure regime is costly, complex and focused on regulatory requirements, while private equity reporting is more closely tailored to investor needs. Furthermore, the rise of shareholder activism presents an increased threat for listed companies. Business owners can choose private equity partners that represent the best fit, rather than wake up on a Monday morning to read that an activist investor has taken a significant stake and is pushing for change.
The final factor is the changing shape of business and the economy. In the last 20 years, company value has become increasingly focused on intangible assets – brands, software and intellectual property – rather than tangibles, like real estate and machinery. As a result, going public may mean disclosing information on a company’s ideas, proprietary technology or core competitive advantage, which makes private investment bound by confidentiality a more attractive option for entrepreneurs.
Today, the world of public equities is populated by more established, larger, less dynamic companies than two decades ago. Many of the fast-growing, innovative businesses are in private equity portfolios. For institutional investors, notably pension funds and insurers, the discussion is evolving from one principally focused on returns into one about portfolio diversification. Investing in private equity is an increasingly important way to guarantee exposure to the growth companies that will shape the next 20 years.
Jason Thomas is Director of Research at The Carlyle Group.
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