Ontario Teachers’ Pension Plan is one of a band of investors increasingly looking to buy the same sort of companies the EQT likes to acquire. Having been unable to invest in EQT’s new fund, which closed at its upper limit of €6.75 billion in August 2015, OTPP then decided to end its relationship with EQT by selling its interests in the firm’s prior funds on the market for second-hand fund stakes.
Jo Taylor, head of Europe, Middle East and Africa for OTPP, said: “EQT has a particular view of what an [investor] needs to be like and, to some extent, we grew apart. We will miss working with them on investments in Scandinavia.”
EQT declined to comment.
The situation is probably not unique. There is a growing concern among a range of buyout firms and industry executives about investors that are looking to buy businesses directly.
Jos van Gisbergen, a senior portfolio manager at Syntrus Achmea, said many private equity firms were questioning “whether this is a healthy development” and added there could be conflicts to consider. Large investors often want to sit on the advisory committee at the private equity fund, according to Van Gisbergen. “They will attend advisory committee meetings where they will discuss the deal pipeline. Then you have essentially a competitor around the table.”
He said that if an investor sits on the advisory committee and also invests directly, it will lead to questions from other investors. “Is that [investor] still independent? It’s an [investor] with a [private equity firm] hat on.” He added that he expects to see an increase in firms banning certain investors from their funds.
This view was echoed by executives from five top-tier buyout firms who refused to comment publicly because the topic is so sensitive.
While in the past investors did not have the staff and sophistication to seriously compete with private equity firms, this has changed in recent years. Several investors have hired experienced deal makers from within the private equity sector. The London office of Canadian pension fund Omers Private Equity is led by Mark Redman – a former deal maker from 3i Group, while Taylor, another former 3i executive, is heading up Emea region for OTPP. Canada’s $ 112 billion Public Sector Pension Investment Board has also bolstered its London team with investment staff from established private equity firms.
Other investors are seen as a threat simply due to their scale and resources. Partners Group, which has about €46 billion of assets under management, is aiming to invest 50% in direct deals, according to a spokeswoman. The Canadian Pension Plan Investment Board, which had assets under management of $ 278.9 billion as of the end of March, invests about 20% directly into companies.
Investors can often afford to pay more for assets than the typical private equity firms, many private equity executives and investors point out, because they are not under significant pressure to generate a 20% annual return, the executives said, as these organisations would be happy with 18%.
Van Gisbergen said: “They can hold on longer to an investment. They are not in the expensive process of fundraising.” He added that they also don’t tend to have to pay carried interest to their teams.
Being beaten to deals by investors could hurt a firm’s reputation. One investor relations executive at a large European buyout firm suggested it adds pressure to find certain deals in a market that is already quite competitive. He said: “If we can’t beat [these investors] in our home countries, why would anyone give us money?”
Some question how institutions doing direct deals source their investments given their dealmakers often couple their own research with knowledge they have obtained through their portfolio of fund investments. John Gripton, a managing director at fund of funds Capital Dynamics, said some of these investors have “a huge database of the firms they invest with”.
“They know when managers are going to sell certain companies and they are very much insiders,” he added.
One investor relations executive said his firm had once received a bid for one of its assets from one of its existing investors.
Others disagree with the notion that the investors have conflicts to deal with.
A spokesperson for Canada’s PSP said: “We recognise that [firms] have capabilities that we don’t have internally and that we won’t try to replicate. We seek to develop and nurture a portfolio of strong partner relationships that have deep sector and geography expertise, and/or that have operating experience to manage the assets we are investing in. Our objective is to have partners that are complementary to us and offer attractive investment opportunities to invest in their funds as well as alongside them through co-investments.”
Not all scenarios need to result in a competition for assets. In some cases, investors and firms eyeing up the same company can end up working together, as was the case on OTPP’s co-investment with Cinven on the €1.75 billion deal to buy Synlab in June 2015. Taylor said that the institution did a big review of the laboratory testing market in the US and Europe as part of its deal sourcing. “We identified Synlab as an attractive target and were familiar with it as BC Partners – who owned Synlab – are a [firm] that we know well. When Cinven asked us to partner with them on buying that business, it was relatively easy to get up to speed and be a responsive partner for them.”
Switzerland-based investor Partners Group, which has become a more direct investor in recent years, has a large database known as “primera” – which consists of information on portfolio companies including cash flows and performance figures that it uses to inform its investment decisions, André Frei, the co-chief executive at the firm, told Financial News in October 2015. Frei said: “It now serves a purpose that goes beyond risk and portfolio management. It’s really a source of information that allows us to connect the dots across our investments and even identify companies that we would like to buy.”
But buyout firm executives and other investors said potential problems can arise with this approach. Van Gisbergen said: “If an [investor] reaches out to a [private equity firm] to buy one of their portfolio companies, the [manager] can say no [if it’s not the right time to sell]. But if they are a large investor and they would want to maintain a good relationship, [they] may be inclined to sell,” he said.
Partners Group said it was not influential enough to sway a firm’s decision on a sale.
There is an added incentive for buyout firms to resist taking capital from investors that do direct deals – they might feel they don’t want to become too reliant on an investor that might move away from committing to funds altogether. A number of placement agents suggested that private equity firms are trying to de-risk their funds by reducing the number of direct investors that contribute. One placement agent said: “If you can get a €100 million commitment from [such an investor], you may only allow them to invest €50 million because you don’t know whether they will still invest in funds by the time you raise your next fund.”
But cutting all ties could be problematic for buyout firms. Some executives say that it is never a good idea to reject investors from a fund because, if they are going down the direct investment route, you may be able to sell them an asset in future.
Some also believe that these larger investors will be careful not to burn any bridges with their fund managers. Being excluded from a well-performing fund can be “a big problem” for some of these large investors, according to Gripton. “I can’t see how they can invest all their money directly. They will need to make fund commitments as well [in order to invest all their money.]”
This seems to tally with the view given by Taylor, who said: “At the moment, we are looking at an investment in Europe where we have asked a local private equity firm to work on it with us. It makes sense to work with a local partner as they know the history of local firms and understand the strengths and weaknesses of the management team.”
Of the C$ 28 billion that OTPP currently has invested in private equity, approximately 30% is still invested in funds and Taylor added that, whenever OTPP considers an investment, it will ask the question why it is better placed than another private equity firm.
“If we don’t think we are, we withdraw. We have done that on a regular basis when this occurs,” he said. And even if it is in a good position to do a deal, the relationship remains paramount, according to Taylor: “If one of our fund managers came to us and said that they are particularly unhappy at us competing with them on an investment, we probably wouldn’t do it.”