Tag: Private Equity

A CDO for Secondaries?

Posted on by

A year or so ago I floated the idea of an index fund for EM private assets.

What if there were an asset manager that could agglomerate a sufficient pool of capital through a publicly listed vehicle (e.g., a super-SPAC) to go out and purchase — in whole or in part — scores of PE-backed companies across EM?

Would a diversified portfolio — at scale — provide better risk-adjusted returns than existing public and private equity funds? 

My bias had been toward equity.

But what if the answer is debt? 

And not just any kind of debt, but securitized debt?

 * * *

Andrew Lo — Director of the MIT Laboratory for Financial Engineering — recently gave a fascinating lecture on new funding models for biomedical innovation as part of the Markus’ Academy series of webinars at Princeton’s Bendheim Center for Finance.

Lo argues that, whilst we’re living amidst a revolution in a variety of ‘omics’ (e.g., genomics, proteomics, microbiomics), to actualize and commercialize scientific and medical advancements, we need a revolution in economics — particularly in how we finance innovation.

At first glance it might seem like an odd proposition.

Even if U.S. venture is exhibiting a ‘diversity breakdown,’ biopharma companies are sitting on $1.5 trillion in ‘firepower’ to fund transactions.

Isn’t there enough funding available already?

Lo asks us to ponder whether it’s worth making a $200m investment in something with the profile of a single anti-cancer compound (i.e., 5% probability of a positive payoff after 10 years of R&D). If successful, annual profits would be $2B / year for 10 years (a present value of $12.3B).

At a 95% failure rate, investing makes little sense.

But Lo points out that if you could invest in 150 programs simultaneously (totaling $30B of capital), the probability of 3 successes out of 150 attempts is 98.18%, and the Sharpe ratio increases from 0.02 to 0.34.

* * *

What if we translate this idea to the EM private markets index?

Would we see:

  • A lower cost of capital for EM companies?
  • Longer runways for value creation?
  • Higher risk-adjusted returns for investors?
  • Lower fees?
  • Greater liquidity (e.g., coupons)?

I don’t know.

But I wonder: maybe — maybe — the solution for the artisanal industry of EM private markets is diversification and massive scale?

— Mike

Viktor Shvets on The Great Rupture

In the latest episode of the Portico Podcast, I speak with Viktor Shvets, a global strategist at Macquarie, and the author of the deeply thought-provoking book The Great Rupture, which investigates the past and interrogates current trends to probe the question: do we need to be free to be innovative, prosperous, or even happy?

You may want to grab a pen and some paper to take notes for this episode because Viktor is a polymath who will engage your brain in some important — and at times, unsettling — thought experiments.

Viktor and I discuss:

  • Why he wrote a book that looks for lessons in the 12th to 15th Centuries to guide us through the next two decades;
  • Whether the ‘operating system’ of open markets, property rights, and open minds that generated prosperity in the past is in retreat — and even if it were, would it matter;
  • The confluence of the information and financial revolutions, and how these two forces are hollowing out the core frameworks of society;
  • The state’s usurpation of the free market and what it means for capitalism and commercial banking;
  • The prospects for emerging markets in an era of de-globalization and the importance of EMs’ non-tradable sectors;
  • Whether universal basic income might liberate people from scarcity and empower them to live lives of their choosing.

But there is so, so much more.

Check it out on Apple Podcasts | Google Podcasts | Spotify

Does PE Investment in Healthcare Benefit Patients?

No.

  • “Our estimates show that PE ownership increases the short-term mortality of Medicare patients by 10%, implying 20,150 lives lost due to PE ownership over our twelve-year sample period. This is accompanied by declines in other measures of patient well-being, such as lower mobility, while taxpayer spending per patient episode increases by 11%.”
     
  • “We find that going to a PE-owned nursing home increases the probability of taking antipsychotic medications — discouraged in the elderly due to their association with greater mortality — by 50%.”
     
  • “We find that PE ownership leads to a 3% decline in hours per patient-day supplied by the frontline nursing assistants who provide the vast majority of caregiving hours and perform crucial well-being services such as mobility assistance, personal interaction, and cleaning to minimize infection risk and ensure sanitary conditions. Overall staffing declines by 1.4%.”
     
  • “A puzzle is why nursing homes are attractive targets given their low and regulated profit margins, often cited at just 1-2%. Using CMS cost reports, we find that there is no effect of buyouts on net income, raising the question of how PE firms create value. There are three types of expenditures that are particularly associated with PE profits and tax strategies: “monitoring fees” charged to portfolio companies, lease payments after real estate is sold to generate cash flows, andinterest payments reflecting the importance of leverage in the PE business model (Metrick and Yasuda, 2010; Phalippou et al., 2018). We find that all three types of expenditures increase after buyouts, with interest payments rising by over 300%. These results, along with the decline in nurse availability, suggest a systematic shift in operating costs away from patient care.”

Bain’s Global PE Report

A few highlights from the year in review:

  • Global buyout deal value reached $592m (up 8% yoy) whilst deal count declined by 24%;
     
  • ~70% of U.S. buyouts were priced above 11x EBITDA whilst ~80% of deals are leveraged 6x or greater; and,
     
  • The number of global buyout exits appears to have fallen below 1,000 — the worst year since 2009.

Hugh MacArthur and Mike McKay ask: Have classic buyout funds run their course?

When I look at the data points highlighted above, I think the answer will turn out to be a resounding ‘yes.’

MacArthur and McKay point to the rise of specialist funds, carving out space for a discussion on the evolution of Vista’s strategy, among other things.

Look. Buyout firms absolutely need a differentiated value proposition.

But in a world of capital superabundance, the average buyout firm offers declining utility as an allocator of capital.

Governance

Speaking of Vista.
 
By now you will have heard that Vista’s founder, Robert Smith, struck a non-prosecution deal with the U.S. government in which he admitted to evading taxes for 15 years.
 
There are some lawsuits alleging mismarked assets and self-dealing.
 
Amidst all the talk about ESG, do institutional LPs value good governance?
 
In the case of Vista, one seems to. Several don’t.
 
But it’s a much bigger question (Abraaj: Redux 👀).

Do institutional LPs actually do their homework on larger funds?
 
Or are the investment teams too cozy with their contractors?

Zhou Xiaochuan and the eRMB

Caixin / Nikkei Asia published an important article from former PBOC governor Zhou Xiaochuan on the landscape for a digital renminbi. This is a space worth watching.

From the Bookshelf

Human history is indeed filled with endless possibilities; and the Renaissance saw this more clearly than either classicism, Catholicism or the Reformation. But it did not recognize that history is filled with endless possibilities of good and evil. It believed that the cumulations of knowledge and the extensions of reason, the progressive conquest of nature and (in its later developments) the technical extension of social cohesion, all of which inhere in the “progress” of history, were guarantees of the gradual conquest of chaos and evil by the force of reason and order. It did not recognize that every new human potency may be an instrument of chaos as well as of order; and that history, therefore, has no solution of its own problem.

— Reinhold Niebuhr, The Nature and Destiny of Man: Volume II. Human Destiny (Charles Scribner’s Sons: 1964)

# # #

The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

Copyright © by Portico Advisers, LLC 2021, all rights reserved.

Ep. 5: Weijian Shan on Leverage and Turnarounds in Asia

Posted on by

In this episode, I speak with Weijian Shan, the chairman and CEO of PAG — a leading Asia-focused alternative investments firm with ~ $40 billion of assets under management.

Prior to PAG, Shan was a co-managing partner of TPG Asia (formerly known as Newbridge Capital).

It was a real honor to have Shan on the podcast, as his life story is remarkable.

If you haven’t read his memoir Out of the Gobi yet, I heartily encourage you to do so. It’s an extraordinary book that recounts Shan’s experiences during the Cultural Revolution — particularly the six years he spent doing hard labor in a re-education camp — and the transformative impact that the normalization of U.S.-China relations and Deng Xiaoping’s economic reforms had on China generally, and on Shan in particular.

And he’s just written a new book called Money Games, which details the rescue of one of Korea’s largest banks on the heels of the Asian Financial Crisis.

I reached out to Shan after finishing Money Games because — in addition to providing one of the few narratives to detail a private equity transaction from sourcing through exit — I think his book offers tremendous insights into the art of private equity deal-making, and I wanted to explore some of the themes it raises.

In addition to his books, Shan and I discuss the importance of stakeholder analysis when structuring private equity investments; whether there is a problem of too much debt in the Chinese economy; SOE reform, and the prospects for China’s economic rebalancing toward domestic consumption; the institutionalization of private equity in Asia; and, his advice for younger people who wish to pursue a career in private equity, among other topics.

Shan’s thoughtful comments prompted me to rethink some of my own analyses and assumptions. I really enjoyed this conversation, and I hope you will, too.

This podcast was recorded in December 2020.

Is EM PE Dead?

Posted on by

When Portico launched four years ago, I asked “Is Emerging Markets Private Equity Dying?”

There’s no need to ask the question anymore.

It’s dead.

You don’t have to take my word for it — the DFIs are telling us so.

For instance, Clarisa De Franco, Managing Director for Africa Funds, Funds and Capital Partnerships with CDC Group, recently told PEI:

I also think we will see fewer new funds emerge as fundraising becomes challenging and consolidation plays out. Our strategy now is two-fold: continue our engagement and innovation with teams that are addressing specific market inefficiencies (including first-time teams) and to back strong-performing existing GPs, with fewer new managers than previously because we believe that will help create a stronger industry that can focus on both financial and developmental outcomes.

Or, look at IFC’s recent report on EM PE funds in the era of Covid-19:

Fundraising in EMs is expected to become more challenging in the next two to three years, especially for funds targeting small and midsize companies. These funds will struggle to survive, while larger and more established funds will be less impacted but still need DFI support. The composition of the Limited Partner (LP) base in EMs will shift, with international institutional investors being constrained in their asset allocations to EMs. The life cycle of funds will see a lengthening in light of longer fundraising cycles and longer investee holding periods due to challenges in achieving exits.

(Also, Actis is eschewing the traditional PE model in favor of hard assets.)

Will there be traditional PE fund managers that raise capital in EM?

Of course.

But a vibrant, growing industry?

Forget about it.

There are capacity constraints, and there are different structures for investing in EM private companies.

Work on a Portico Pivot™️ is underway. 

* * *

 I recently recorded a podcast episode about private equity in Russia. I hope we get to release it.

During the conversation, the guest and I got to talking about the transition from the Soviet Union to what came after, and how generations experienced the shift differently. For instance, people aged 40+ often had difficulty adjusting to new conditions, while younger people benefited from a lack of habits and legacy thinking that communism had engrained in the older generations.

The discussion reminded me of a passage from Sebastian Haffner’s Defying Hitler. Recalling events in Germany in 1923, Haffner wrote:

The old and unworldly had the worst of it. Many were driven to begging, many to suicide. The young and quick-witted did well. Overnight they became free, rich, and independent. It was a situation in which mental inertia and reliance on past experience were punished by starvation and death, but rapid appraisal of new situations and speed of reaction were rewarded with sudden, vast riches.

Speaking of Weimar, the feeling that the United States is on the cusp of a crucible is palpable.

It’s banal to say that Covid-19 has been an accelerant for long-standing trends, but in the last couple of months it feels as if the fissures have broken open.

Perhaps it’s the paranoia of a c. 40-year-old American who fears getting caught flat-footed, but the international system that has defined my existence is gone, and it’s not going to be reclaimed.

The urgency to adapt is acute.

 * * *

If you are a U.S. citizen, please vote in this year’s election.

Election Day is Tuesday, November 3rd.

The website www.vote.org is helpful for finding out which voting options are available in your locality (e.g., early in-person, absentee by mail), and locating your polling place. 

Vote!

Alla prossima,
Mike

Asia

Two recent pieces on private equity in Asia caught my eye. 

1.McKinsey & Company interview with Baring Private Equity Asia Founding Partner Jean Eric Salata.

Insightful take on the deepening of the Asian market — not only in terms of the strategies and sectors that attract investment, but also in terms of the evolution of human capital and the professionalization of asset management firms. Particularly thoughtful on the necessity of infusing digital capabilities throughout one’s operations and the investment cycle.

2. BCG report on The Promise for Private Equity in Asia-Pacific. 

There’s not much new in it, candidly, but it rightly points out the heterogeneity of investors in private markets, and it has a useful data nugget: “As of 2018, China, India, South Korea, and Thailand all ranked in the top 10 countries globally for number of family-owned businesses with market capitalization of over $250 million.”

While Portico has been cautious on investor exuberance toward mega-cap Asia and China-dedicated funds — and we watch the dogpile into Jio / Reliance Retail quizzically — the region is core.

On this point, Benedict Evans put out a thought-provoking essay on “The End of the American Internet.” Upwards of 90% of internet users are outside of the United States; China and India have 5x as many smartphones as the USA; and, the “RoW” (largely China) accounts for nearly half of global venture investment.

Someplace Else

The placement agent Eaton Partners conducted an LP Pulse Survey in September. They asked LPs which region is home to the best private market opportunities. 

The verdict: 

  • North America — 68%
  • Europe — 18%
  • Asia — 14%
  • “Someplace else” — 0%

Josh Lerner on U.S. Venture

One of the assertions I put forward last year is that the institutionalization of U.S. venture capital is leading to less innovation.

Josh Lerner and Ramana Nanda published a paper over the summer that argues a similar point. In short:

Three issues are particularly concerning to us: 1) the very narrow band of technological innovations that fit the requirements of institutional venture capital investors; 2) the relatively small number of venture capital investors who hold and shape the direction of a substantial fraction of capital that is deployed into financing radical technological change; and 3) the relaxation in recent years of the intense emphasis on corporate governance by venture capital firms.

Stash

Sometimes it’s fun to contemplate the embedded assumptions amongst the venture community.
 
For instance, Anish Acharya at Andreessen Horowitz wrote a blurb about Stash, a fintech startup that enables people to earn fractional shares as a reward when they use the Stash debit card at a merchant (i.e., you get a slice of Starbucks stock when you purchase a pumpkin spice latte or whatever).
 
Acharya believes bringing the ‘intelligent default’ to the 401(k) — making it opt-out as opposed to opt-in — is “one of the biggest forces for financial progress.”
 
Oodles of assumptions about financialization, ‘nudge’ psychology, etc.
 
Anyway, Stash is positioned as a way to help regular people build wealth … by spending their money. (There’s a monthly fee of $1 to $9, btw).
 
At first glance, this seems like a good idea. Rather than points or cash back, why not acquire a fraction of a share of stock?
 
But if you think about it for a minute longer, you’ll realize that it ‘nudges’ consumer spending toward large, publicly listed companies, leaving smaller, privately held businesses in a lurch.

From the Bookshelf

The boy thought he smelled wet ash on the wind. He went up the road and come dragging back a piece of plywood from the roadside trash and he drove sticks into the ground with a rock and made of the plywood a rickety leanto but in the end it didnt rain. He left the flarepistol and took the revolver with him and he scoured the countryside for anything to eat but he came back emptyhanded. The man took his hand, wheezing. You need to go on, he said. I cant go with you. You need to keep going. You dont know what might be down the road. We were always lucky. You’ll be lucky again. You’ll see. Just go. It’s all right.

I cant.

It’s all right. This has been a long time coming. Now it’s here. Keep going south. Do everything the way we did it.

You’re going to be okay, Papa. You have to.

No I’m not. Keep the gun with you at all times. You need to find the good guys but you cant take any chances. No chances. Do you hear?

I want to be with you.

You cant.

Please.

You cant. You have to carry the fire.

I dont know how to.

Yes you do.

Is it real? The fire?

Yes it is.

Where is it? I dont know where it is.

Yes you do. It’s inside you. It was always there. I can see it.

Just take me with you. Please.

I cant.

Please, Papa.

I cant. I cant hold my son dead in my arms. I thought I could but I cant.

You said you wouldnt ever leave me.

I know. I’m sorry. You have my whole heart. You always did. You’re the best guy. You always were. If I’m not here you can still talk to me. You can talk to me and I’ll talk to you. You’ll see.

Will I hear you?

Yes. You will. You have to make it like talk that you imagine. And you’ll hear me. You have to practice. Just don’t give up. Okay?

— Cormac McCarthy, The Road (Vintage: 2006)

Haven’t signed up for our newsletter yet? Sign up now.

# # #

The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

Copyright © by Portico Advisers, LLC 2020, all rights reserved.

Ep. 2: Private Equity & Development

Posted on by

When I decided to launch the podcast, I wanted today’s interviewee — Roger Leeds — to be one of the first guests. And I wanted to explore the theme of private equity and its role in private sector development in emerging and frontier markets.

A bit of background may be helpful.

15 years ago or so I was working for the Department of Defense on strategies to address a variety of intractable issues.

For one such issue, I was the youngest member of an interagency team working with senior civilian and military commanders in Baghdad and Kabul on interior ministry and police reform.  U.S. policymakers had dubbed 2006 the “Year of the Police,” but as the year passed by, the results trickled in; and I grew increasingly skeptical about the ability of the United States to effect positive and enduring change in Iraq. 

Moreover, when viewed in a broader perspective of state-building, counterterrorism and U.S. national security objectives, I became convinced that the only viable long-term solution was to drive investment into the region, create jobs and, over time, generate licit opportunities for people to feed their families.

So, it was off to grad school to study economics and finance, where I serendipitously learned about something called private equity and how it could drive private sector development in emerging markets.

Roger Leeds taught that course. He had a profound influence on me when I was a student at the Paul H. Nitze School of Advanced International Studies (SAIS), and his positive influence endures to this day.

Roger worked as an international financier for 25 years before joining the faculty at SAIS. After working as an investment banker at Salomon Brothers, Roger was at the forefront of the development of the emerging market private equity industry, not only as a senior staff member at the International Finance Corporation, but also as a private equity investor, and as the co-founder of the Emerging Markets Private Equity Association (EMPEA).

Roger is the author of Private Equity Investing in Emerging Markets: Opportunities for Value Creation — the seminal book on the topic, which I encourage every listener to pick up and read.

In our discussion today, we talk about the structural drivers that make private equity a useful investment strategy in emerging markets, and how it is qualitatively different than the leveraged buyout model that is prevalent in the United States and Western Europe.

We also talk about the hollowing out of mid-market PE funds in emerging markets and why it’s a problem, the story of local currency PE funds in China, and his work with Francis Fukuyama on the Leadership Academy for Development, among other things.

I hope you enjoy our conversation.

This podcast was recorded in July 2020.

Buy Roger’s book directly from the publisher, or via Amazon, Barnes & Noble, IndieBound, JD.com, or wherever fine books are sold.