- Capital Call by OneFund
- Themes in Private Capital M&A and GP Consolidation Dynamics
Themes in Private Capital M&A and GP Consolidation Dynamics
Capital Call - a bi-weekly newsletter from LPs for LPs, covering the latest and greatest from across the private markets
Calling all LPs!
Welcome back and thanks for joining me (John Bailey, Co-Founder at OneFund) for another week of Capital Call.
A bi-weekly private equity newsletter from LPs for LPs.
In this edition, I cover:
Themes in Private Capital M&A and GP Consolidation Dynamics
Fundraising updates and VC/PE reports
GP Perspectives from Henry McVey & The Fintech Fund
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According to Bain’s latest report, M&A is currently spiking in private capital (i.e., PE and VC funds), a sector that has historically deterred consolidation. With over 15,000 private capital firms, there are nearly limitless ways to strategically add scale through M&A, including expanding geographies or asset classes. However, countless deals die out as integration complexities such as culture clash, compensation & carry, and talent retention arise.
But now sponsors are willing to work through these headaches as industry trends encourage consolidation. Private capital is seeing a race to expand AUM, putting pressure on GPs to find new growth strategies. Additionally, smaller firms are facing disproportionate fundraising hurdles, forcing many to consider joining a larger platform.
The above chart depicts elevated levels of strategic private capital M&A in 2021 and 2022. The trend is expected to grow as M&A activity is still minuscule compared to the size of the industry. In this week’s capital call, I’ll dive further into how M&A is transforming the private capital industry and what the recent uptick in activity means for LPs.
Public Sponsors Have Significant Advantage in Conducting M&A
84% of private capital acquirers are public firms. Not only are acquisitions easier for them, but they also face significant pressure to achieve 15%+ growth in fee-bearing AUM by shareholders. Sustaining this growth often means adding asset classes, geographic expansion, new customer channels, and strategic distribution. M&A can accelerate all these strategies.
Public sponsors are then able to use their strong, liquid balance sheets to create flexible and attractive deal structures while private sponsors face the challenge of financing mergers out of partners’ own pockets without much access to debt.
These reasons may explain why Sweden’s EQT had never conducted M&A before it went public in 2019 but acquired five sponsors since then. EQT notes that their recent Asia expansion would have taken over ten years to complete if they had not acquired a local sponsor.
LPs involved with public alternative managers can expect a high likelihood that their GPs are interested in acquisitions. If M&A is conducted, LPs should ensure GPs are prepared for the integration complexities and operational questions that arise and that resources are not diverted away from their current commitments.
Asset Class Expansion is the Main Strategic Rationale for Integrations
Nearly 50% of private capital M&A is done for asset class expansion, followed by 18% for access to funds and 17% for geographic expansion. Though asset class expansion is typically done organically, rapidly expanding asset classes such as credit and real estate can require significant scale to compete. As a result, these two asset classes comprise a dominant 60% of asset-class driven M&A in private capital.
LPs involved with public sponsors are likely to see the range of asset classes covered by their manager expand, giving LPs the option to leverage pre-existing GP relationships to gain exposure to other attractive sectors. LPs committed to strong single-strategy firms in sectors such as real estate and credit may also have this option if their manager is acquired by a larger platform.
Navigating the Integration Conundrum and how it Affects LPs
Though the strategic rationale for private capital M&A may be clear, post-merger integration in this industry will always remain a long, shaky process. Retaining key talent in target firms is the key priority and can be especially difficult in an industry where proprietorship and entrepreneurialism are prominent employee traits.
Standard back-office synergies may be realized quickly, but it will be difficult to integrate other components that seem simple such as investor relations. Longstanding client relationships are crucial in private capital and eliminating overlap too quickly on this front may reduce fundraising speed or volume.
These reasons are why the most successful private capital integrations are not rushed and take place over lengthy periods. Giving the acquired firm initial independence will reduce friction, and acquirers can work on integration as original team members gradually move on.
LPs involved with both acquiring sponsors and target sponsors should understand the fragility of the situation and anticipate integration outcomes. M&A that is executed poorly or too fast can result in rapid talent outflow and LPs must reassess whether the team can still execute on the initial vision. On the other hand, well-constructed sponsor integrations will result in minimal near-term changes in fund execution and will allow LPs to take advantage of joining a larger investment platform providing more optionality in the future.
Updates from Across the Ecosystem
In KKR’s mid-year macro update released last week, Henry McVey provides his views on the complexity of the current environment. According to McVey here are three key trends to consider:
It’s Actually Been the Fastest Economic Recovery Since the End of World War II
McVey believes there’s an intersection of poor near-term fundamentals that is more than offset by a stronger long-term backdrop as evidenced by stronger nominal GDP growth compared to past cycles. KKR’s position is that investors are far too conservatively positioned at the moment.
While Inflation Likely Has Peaked, KKR Believes a Regime Change Has Occurred
McVey believes in a “higher resting heart rate” thesis where inflation will remain sticky and above the Fed’s 2% target by the end of 2024 contrary to the TIPS curve suggesting inflation dipping below 2%. However, this higher inflation will be coupled with higher-than-expected GDP growth, especially in the U.S.
KKR’s Framework Suggests we are in a Mild Contractionary Phase in the U.S.
Cyclical leading indicators suggest a mild contractionary phase. However, KKR does not expect the same severity of economic downside as in past cycles. This is supported by a strong technical backdrop, low unemployment amidst strong nominal GDP, and more fiscal spending.
The FinTech Fund, a GP focused on early-stage FinTech / InsureTech, notes that the valuation multiples across the top 5% of fintech firms and the median are converging to similar levels.
The enormous multiples of prior years will not be seen as the industry follows a more fundamental valuation approach. Multiples in the private markets for fintechs are expected to follow suit.
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