Capital deployment and bottom line protection
Maintaining rigorous processes to find high-quality assets is one way to bolster performance in a downturn.
The right culture and the right set of checks and balances and controls are also important when things get tough, according to a panel of experts moderated by Carlyle Group’s Ruulke Bagijn at SuperInvestor 2019 in Amsterdam.
As the macroeconomic environment becomes riskier, general partners need to weigh the context of a changing backdrop against the opportunities arising from the proliferation of technologies and disruptive forces, and focus on finding the areas where the most value generation is taking place.
“It’s all about placing our capital on the right side of this watershed,” said Kurt Björklund, the co-managing partner at Permira. “Backing industries that have strong long-term thematic growth. You have to be really careful about how you think about fundamental value when you invest.”
As for whether they feel defensive, the panel explored what would happen if there was a downturn or recession. Slowing growth makes for a difficult environment and makes analysis even more important to determine the strength of the business and whether it can survive.
“If a business is starting to come off, you need to be clear whether that is structural or cyclical, so it could bounce back,” said Robert Lucas, Managing Partner, CVC Capital Partners. “That’s critical to deciding whether to hang on or exit the investment.”
Chris Caulkin, Managing Director & Head of Tech for EMEA at General Atlantic gave the example of a deal that his firm had stuck with through a slow patch – the pan-European job portal StepStone. Sticking to their belief that the company would survive the cyclical factors at play, his firm benefited from structural changes when advertisers switched to online, away from traditional magazines or newspapers.
Even so, the panellists said it was important to be mindful of the debt levels and how appropriate they are for the economic cycle, leaving room for manoeuvre should things get tough.
“However resilient the businesses you back are, you will still have a macro effect,” Björklund said. “You still have the problem that corporate expenditure is going down and consumer spending is going down. You never want to be hamstrung by debt.”
In a downturn, factors including how much control a firm has over and investment and the personalities involved can become more exposed and more important.
CVC Capital Partners’ Lucas said having the right internal culture and the tools to take action were more important than the level of absolute control.
“When things get tough you want to have a culture internally that encourages people to bring forward issues early,” he said. “You can have all the control in the world, but if you haven’t spotted an issue and got in to it early, then you’re in trouble.”
For Caulkin, being a minority investor isn’t an issue. It’s not about being passive as a minority investor, it’s about the bigger picture, he said, and that means making sure the due diligence is done properly and there is real, genuine alignment among the investment partners.
There are great opportunities in the European tech sector, and more of those businesses are going global, creating even bigger opportunities to invest.
Andrew Sheiner, Founder & Managing Partner at Altas Partners, explores what can trigger a downturn and the precautions managers need to take to keep their ships afloat.
The panel discussed the relative merits of investing for different durations.
Björklund said it is very hard to forecast out beyond 10 years, so constant reassessment is needed. “Often something happens that you can’t predict,” he said, as he advocated a model where 20 assets were put into one fund, and then 15 or so are sold at a certain point, leaving the core 5 that are known really well to perform into the future.
CVC Capital Partners’ Lucas said his firm are “constantly reassessing” the assets in its longer-term funds and that gives flexibility.
“In past downturns a lot of companies emerged as better competitors,” said Matt Cwiertnia, Co-Head of Private Equity, Ares Management. “The ones who got really hurt were the lower-quality companies that were already losing share. The numbers didn’t add up.”
So, in the current climate, GP success hinges on a quest for high-quality assets, trying to be on the right side of structural change, being able to act when times get tough, and avoiding conflicts of interest. When slowdowns take hold, it’s even more important to get the basics right.