Gradually Regaining Ground
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TheSummer first 2011 in a series of 2011 Wharton Private Equity Review:s 2011 Wharton Private Equity Review: Gradually Regaining Ground http://knowledge.wharton.upenn.edu Sponsors PennLauder CIBER The Joseph H. Lauder Institute of Management & International Studies With additional support from Private Equity and Venture Capital Club THE WHARTON SCHOOL Summer 2011 2011 Wharton Private Equity Review: Gradually Regaining Ground The financial meltdown of 2008-2009 and the resulting global recession dealt a painful blow to private equity investing, and the industry is still recovering. In this special report, based on the 2011 Wharton Private Equity and Venture Capital Conference, Knowledge@Wharton examines the industry’s gradual comeback. Contents Battling Headwinds: Private Equity’s ‘Bright Future’ in Technology and Developing Economies 3 Forward-looking private equity investors can still reap strong returns from global growth opportuni- ties, despite the powerful headwinds that are buffeting the U.S. economy. That was the assessment of Glenn Hutchins, co-founder and co-chief executive of private equity firm Silver Lake, in a keynote address during the 2011 Wharton Private Equity and Venture Capital Conference. Although high unem- ployment, excess capacity and a backlog of unsold housing remain problematic in the U.S., technology and booming economies in Asia and the developing world offer a wealth of prospective investments, Hutchins said. As ‘Megadeals’ Lose Luster, Mid-sized Companies Are Becoming More Attractive 6 Private equity investors are increasingly focused on strong middle-market companies that are ready to expand. Investments in such companies demand less capital than larger deals and have greater flexibility when it comes to cashing out. This makes middle-market investing particularly attractive to private equity firms at a time when money remains tight and fund-raising is challenging in the wake of the global recession. Where Markets Are Hot: Opportunities for Venture Capitalists Across the Globe 9 The prospect of reaching vast numbers of new middle class consumers in emerging markets is a driving force in international private equity and venture capital. In China, India, Southeast Europe and Latin America, sizable populations of young consumers are eager to enjoy the goods and services available to those in the United States and other developed countries. Top targets for investment in these emerging markets include companies in the Internet, financial services and clean technology sectors. Let’s Make a Deal: Distressed Companies Appear Ready to Turn to Private Equity 13 Troubled companies that have been hoping for better times will soon have to turn to private equity investors for sorely needed funds. That was the consensus of a panel on distressed investing at the 2011Wharton Private Equity and Venture Capital Conference. Companies that have renegotiated bank loans six or seven times will need to resort to other options, the panelists said. Among the sectors most likely to provide distressed opportunities are real estate, finance and health care. Battling Headwinds: Private Equity’s ‘Bright Future’ in Technology and Developing Economies Forward-looking private equity investors including telecommunications provider MCI and can reap strong returns from global growth TD Ameritrade Holding Corp., a financial services opportunities, despite the powerful headwinds firm. But this time, the “bounce back is anemic that are buffeting the U.S. economy. That was the by contrast.” assessment of Glenn Hutchins, co-founder and Among the major signs of weakness that he co-chief executive of Silver Lake, a global private cited: investment firm, in a keynote address during the 2011 Wharton Private Equity and Venture Capital • Unemployment: Hutchins called joblessness Conference. the single most important part of the economic picture. Laid-off workers have currently been Technology and booming economies in Asia unemployed for an average of 34.2 weeks — and the developing world offer a wealth of more than 60% longer than in past economic prospective investments, ranging from health cycles. “This has long-term consequences for care to wireless technology, Hutchins said in a families and kids,” he pointed out, noting that talk titled, “Endgame: The New Economy.” “If it becomes much harder for people to find you can position yourself in a growing part of work after six months of unemployment since the U.S. and the global economy, there is a very their skills and business networks begin to bright future ahead of you,” noted Hutchins, grow stale. whose firm has $14 billion in assets and offices in New York, California, Europe and Asia. Technology and booming economies in Hutchins called the 2008 global financial collapse the worst he has seen in his business career. The Asia and the developing world offer a former adviser to President Clinton on health care wealth of prospective investments, ranging and economic policy said the crisis is a reminder that even the best investors can be “hurt badly” from health care to wireless technology. if they misread economic conditions. Lingering effects of the crisis still haunt the Meanwhile, more jobs have been permanently economy, he noted. For example, the current lost in the latest decline than in previous recovery is far weaker than those that have cycles. While laid-off workers were frequently typically followed a U.S. downturn. “Usually, hired back by their employers, today’s the deeper down you go the steeper you unemployed must often find new jobs with come back,” said Hutchins, who is chairman other companies, Hutchins said. New jobs of SunGard Corp., a software and technology most often come from small companies services provider, and a director of companies that are expanding, he added, but the funds 3 Gradually Regaining Ground available for such expansions have “declined making it extremely difficult for the economy precipitously” in the wake of the global to grow while government, consumers and financial meltdown. businesses shed debt. Consumer borrowing fell for a record nine straight quarters as of the end • Excess capacity: Only about 76% of U.S. of 2010, for example, and consumers have lost manufacturing capacity is now in use, some $1 trillion in purchasing power as a result Hutchins said, compared with the historic of the recession. Debt-burdened consumers are norm of 82%. And the service sector, a source reluctant to borrow, even as credit becomes more of growth in past recoveries, also lags because readily available. these jobs are increasingly outsourced to other countries. The rate of economic growth in the This increase in saving is taking place at “just U.S. service sector is now just 0.5%, compared the wrong time,” since what the economy needs with more than 2% in the previous two most is a surge in demand from consumers, recoveries. “The services engine has slowed whose spending accounts for some 70% of GDP. down,” said Hutchins. “An increasing amount Investors must thus make a judgment about of professional services — architecture, whether consumers will go back to “aggressive engineering, consulting, legal, accounting — borrowing and shopping,” he said. has gradually been able to migrate outside the United States.” The Weight of Budget Deficits Major corporations are increasingly relocating Also weighing on the economy are government to other countries as well. “People understand budget deficits around the world, which Hutchins that GDP has moved outside the developed called a major threat to the recovery. But “you world. They get that jobs have gone with it. can’t take the patient off life support until he can But what they really don’t understand is that sustain himself,” he added. “You have to take the corporate activity has gone, too,” Hutchins stimulus out of the economy relatively gently,” said. Nineteen of the world’s 25 largest since a sharp pullback could trigger the kind companies in market value were based in the of double-dip downturn that the United States United States in 1999, he noted, compared suffered in 1937. with just 14 today. At the same time, Hutchins applauded the • Real estate: Housing remains the heaviest deficit-cutting moves that the co-chairmen of drag on the recovery, said Hutchins. The U.S. the bipartisan National Commission on Fiscal housing industry currently has a 24-month Responsibility and Reform recommended last supply of unsold homes — including those in December. “There’s a roadmap already out there. foreclosure — or four times what economists The question is, do we have the political will to consider the optimal level of supply. Weak do it?” housing prices reflect this unsold inventory: Looking five years ahead, Hutchins predicted the While prices typically show a 26% gain in the global economy will expand through 2015, with first year of a recovery, in 2010, home prices most of the growth coming in Asia and other were down 1% from the previous year. parts of the developing world. Silver Lake is The impact of the 30-year buildup of debt that gearing up for this, he said. Employees are told, preceded the 2008 financial crisis is also impeding “You may not like the food. You may not like the the recovery. Debt reached 350% of the U.S. Gross jet lag. You may not like missing your kid’s soccer Domestic Product (GDP) that year, according game, but you’ve got to go” to the emerging to Hutchins — more than twice the level that markets, particularly Asia. “Not only that, but preceded the Great Depression. “This was not we’re going to move you there.” a product of one decision,” he said of the vast Middle class consumers in emerging markets buildup before the recent crisis. “It was not a often look for products that are far different from product of one bubble. This is 30 years of excess in what U.S. companies produce, Hutchins added. borrowing in almost every sector of our society.” He pointed to the popularity of ultra low-cost Such borrowing “sticks with you,” he noted, 4 Knowledge@Wharton 2011 Wharton Private Equity Review: Nano cars in developing countries, as opposed opportunities in investing in the efficiency and to sports utility vehicles from Detroit automakers.