Our podcast, Torys in 10, features quick, candid conversations with our lawyers on issues affecting your business: critical changes in the law, deal trends, market and industry developments and more.
Mike Akkawi and Guy Berman dive into some of the findings from PE Pulse. Hear from the pair as they talk about the large deal sizes the PE market saw in 2019 and the reported expectations that these deal sizes will stay the same or increase moving forward as well as fundraising and how pension fund survey respondents said their allocation of private equity will either stay the same or increase throughout the year.
A full episode transcript follows.
Mike Akkawi (00:12): Okay, so this is the first podcast by the Private Equity group at Torys on our Torys in 10. I am Mike Akkawi, I’m a partner in the Private Equity group and I’m here with my partner, Guy Berman, also a lawyer in our Private Equity group. We started about the same time we both been at the firm for 20 years or more, Guy?
Guy Berman (00:33): 20 years plus.
MA (00:36): 20 years plus. Which takes us to the topic that we have here for you today. It is on the Private Equity Pulse 2020 Canadian Private Equity Survey. Now that’s a survey that we conducted at our firm working with Ipsos and reached out to a number of private equity sponsors and a number of investment professionals at the pension funds and other clients of ours who are directly in the private equity space.
We got a response by over a hundred of our clients and contacts and we wanted to chat about this: The first—the inaugural—private equity survey in Canada, we don’t believe there’s anything else similar to it. And just very quickly you can access it, the survey that, is on our website, torys.com. Go either to my link, Michael Akkawi, or to my colleague’s here, Guy Berman, and you’ll find you’ll find the survey.
Guy, over to you to set up what we’re going to talk about.
GB (1.40): Excellent. Thanks Mike. So, when you guys have had a chance to read our survey, you’ll see that it’s rich in data and showing where our private equity clients and pension fund clients think we’re going in the future. There were a couple things that surprised us, and we wanted to focus more on those topics for this podcast.
The first one is the large deal sizes and clients’ expectations that deal sizes will continue to stay the same or increase. And why is that surprising? In 2018, the average deal size by a private equity buyer in Canada was C$292 million. And that more than doubled to over C$600 million in 2019. And what we saw was 91% of our private equity clients thought deal sizes would stay the same or increase. And you know, ultimately, Canada is a mid-market country with mid-market companies and we would’ve expected that deal sizes will kind of revert to the mean and be a bit lower.
(02:44): Now, that doesn’t mean that there isn’t good rationales for why deal sizes are higher. And I think that’s what we want to dive into here. So the first one is in, I’ll call this in the pure mathematics category. [In] 2019, there were a whole bunch really large cap deals and that obviously skews a deal sizes higher: we saw Onex buy WestJet for almost over C$6.5 billion; Blackstone bought Dream Global for almost C$6 billion. Again, that really increases average deal sizes. But there are some other trends that we’ve seen in the marketplace. Debt is really cheap now, which obviously helps with valuations and doing deals. There is a lot of competition in the marketplace: our pension funds or private equity funds have more capital than they’ve ever had; there are new entrants in the private equity market; pension funds are very active and have a lot of dry powder; and all of that leads to more capital chasing deals.
And what we’re seeing is that it seems like almost every year now, for the last five years, we hear that valuations are at an all-time high. And so, over the last five years our clients—whether they’re corporate clients or private equity clients—if they have assets they want to sell they always think it’s the best time to sell at the peak. And they’ve been selling over the last five years. And I think what’s really happened is that there are fewer and fewer great assets coming to market and when those assets come to market there is a lot of interest and inevitably we see lots of auctions with high valuations for those top assets. I mean, Mike, we’re seeing this with deal terms, too.
MA (04:35): Yep, you’re right. We’re seeing as, I think the market is predicted for a number of years. But it’s really become far more common these days and in other words, we’ve hit there. Where most of our deals or many of our auctions for good assets is, as you said Guy, are done on almost, you know, public company terms—obviously backed up by rep and warranty insurance to deal with the risk.
I agree with you; I think competition is really the base reason for why deal sizes are maybe out of whack a little bit over the last couple of years. I look at it as we’ve seen our clients move into different sectors, focusing in areas that you have not seen private equity make investments in. And this is almost like its own new sector, you know, the “large cap sector”, and only some of our clients can play in that field, some of the private equity shops in the country. When you add in, as you said cheap debt on good terms and also lots of co-invest demand, they can play in that market and get opportunities that are maybe dwindling or less common these days in the mid-market where they’re used to playing.
GB (05:52): That’s a good point. A lot of mid-market players are using co-investor money to do larger deals. And we’ve seen the Canadian private equity funds are raising larger and larger funds and as a result they have to deploy more capital and it’s easier to do that by doing larger deals than smaller deals. So, we’re seeing a bit of a self-fulfilling prophecy here.
The other thing that is of note is we’ve all seen the number of IPOs over the last 10-plus years really decrease, but in the last five years—and we’ve seen this at Torys, a lot—where we have these dual track processes where clients are either going to IPO or sell as a private sale. And you know, in almost every single one of those dual tracks, we ended up having a private sale cause the private company multiples are now approaching the IPO. We’re surpassing IPO multiples.
MA (06:48): Right, I think that’s exactly right. And you know, also why create the headache of getting into the public markets and all the complexity that surrounds securities laws, which luckily neither one of us focuses on.
GB (07:02): Yeah, but we do have colleagues at the office who are experts in that field and would love to take your call.
MA (07:07): There you go.
GB (07:08): That’s a really good segue for our next topic, which focuses on fundraising. So we just talked about how there’s a ton of dry powder in the marketplace, private equity funds are raising more and more capital. And what we saw was our pension fund clients, 79% of them said that their allocation to private equity will either stay the same or increase, which is a reflection of what a great asset class private equity is. And so, despite all of that, what we found surprising was that more than double our respondents thought that in the coming years it was going to be more difficult to raise capital. 43% of our respondents that it was more difficult to raise capital in 2020 and beyond for their next fundraise. Mike, I found this surprising, I know you did as well. What do you think led to that?
MA (07:57): Yeah, so I agree. I think it’s a surprising stat and maybe the quickest, easiest answer or explanation is that, none of our contacts want to go out there and say it’s just going to be easy. It may be better to be a bit conservative in responding to your prospects of raising a new fund. So that’s just more of a feeling than an answer based on the survey. An answer based on the survey though is that a lot of our respondents came back and said that they expect geopolitical or macroeconomic risks and concerns to be their biggest concern looking forward. So, they’re probably tying obviously that into the fact that they may not be able to raise capital as easily.
GB (08:49): And to dig in on that, it was almost 30%, when we asked them what your biggest challenge in the future, almost 30% said it was some kind of macro issue. So, 12% identified an economic downturn or recession, 8% identified geopolitical uncertainty and 7% identified uncertainty in the macro environment. It wasn’t a multiple-choice list, this is what they identified.
MA (09:16): Right. And this was actually maybe from a timing perspective, worth mentioning, that the survey was just before the COVID-19 outbreak so those numbers may look worse today. And you know, especially since we’ve seen what’s happened in the public markets. But in addition to these possibilities, one other trend that we’ve been seeing that would have an effect on fund size is the co-investment strategy or, maybe more generally, the private equity investment strategy of some of the pension funds out there. Many still have a large fund investment strategy, but that’s often now tied together with an interest in a co-investment strategy and access to co-investments from their underlying funds. So, in order to do that more effectively, we’ve seen a lot of our clients on the pension fund side, narrow their relationships, reduce the number of contacts that they have with sponsors to build deeper relationships with those sponsors in order to get more access to co-invest opportunities. And similarly, sponsors have reciprocated with various of their investors.
(10:33): So from that perspective alone, and we can reinforce this point by looking at the number of secondary transactions we’ve seen in the market where pension funds have sold entire portfolios of private equity investments, investments in private equity funds in order to limit their relationships. But that could be another reason that we’re looking at an environment, and our clients are looking at an environment, where the pension funds are being more selective in the number of relationships they have and who they have them with. And so that’s creating a little bit of uncertainty on the side of the sponsors and in looking forward to their next fund.
GB (11:15): From a pension fund perspective, they’re not reducing their allocation to sponsors, but they’re reducing the number of sponsors they invest in. So, we’ll probably see some winners who get lots of the money from the sponsors, but as a result, there’ll be some losers. And for those guys it will be harder to raise capital. Maybe that’s the explanation.
MAMA (11:36): That that would be a good, sophisticated explanation for what’s happening if we don’t rely on our first two answers, which were also very likely.
GB (11:46): I paid him to say good and sophisticated.
MA (11:48): So, I think that’s it. We covered, again, two topics that we thought were very interesting in our survey, which you can access as we mentioned earlier on the podcast, at torys.com. And you can also reach out to Guy or me, on any of these topics. And thank you very much for listening.
GB (12:06): Thanks, and see you soon.
Music: Stratosphere - www.adamvitovsky.com
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
For permission to republish this or any other publication, contact Janelle Weed.
© 2020 by Torys LLP.
All rights reserved.