Coller Institute of Private Equity FindingsINSIGHTS from the world’s best prIVATE EQUITY RESEARCH ISSUE 8 SPRING 2013 / £25 $40 €30 ........................ .. ........................ .. ........................ .. ........................ .. TALENT MAGNET A POSITION ........................ .. ........................ .. How PE firms attract, incentivise and ........................ .. retain top CEOs /6 OF POWER $ ........................ .. How large LPs influence GP ........................ .. deal decisions and how SECOND HANDS this affects fund Drivers of liquidity and pricing performance. And, should other LPs in PE secondaries /8 be concerned? THE RIGHT MEDICINE How to transform a small, orphan business into a global force /15 RISKY BUSINESS? Are LPs being compensated for PE’s illiquidity? /18 OVER THE HORIZON How a fund’s lifecycle affects GP risk appetite /24 INCLUDING CONTRIBUTIONS FROM: BOOTH SCHOOL OF BUSINESS, UNIVERSITY OF CHICAGO l COLUMBIA BUSINESS SCHOOL l HEC PARIS l LONDON BUSINESS SCHOOL l NYU STERN l SAÏD BUSINESS SCHOOL, UNIVERSITY OF OXFORD l SWISS FINANCE INSTITUTE l © LONDON BUSINESS SCHOOL 2013 CONTENTS 4 By the numbers SWF rapid growth continues; private equity still outperforms others; Asia-Pac sellers thwarting deals; China faces exit backlog; global exit overhang worsens. 6 Pushing performance Private equity portfolio company CEO contracts are widely viewed as providing effective incentives for CEOs to drive value. Recent research looks at how some of the top buyout houses structure these and asks whether public companies could learn a thing or two. 8 Trading places What drives liquidity and pricing in the increasingly large private equity secondaries market? New academic research lifts the lid on this opaque market. 11 A position of power How should other LPs view the involvement of a larger investor? We explore a new paper that asks how much influence bigger LPs have on PE fund deals and exits and how this can impact performance. 15 Going global A new case study examines how Nordic Capital transformed a small, regional orphan company into a global leader, generating sizeable returns in the process. 18 Risky business? Are LPs being adequately rewarded for PE’s illiquidity? And do the industry and its investors measure this and other risks appropriately? We debate with two academics and three practitioners. 24 The horizon effect The latest Coller PhD Prize-winning paper explores how the stage in a fund’s lifecycle affects GPs’ investment choices and risk appetite. We explore the key findings and ask: what effect does this have on fund performance? 26 Coller Institute of Private Equity news The Coller Institute, among others, hosts a lively debate that focuses on the risks and opportunities for private equity investment in Russia. 2 | FINDINGS | spring 2013 Editorial board Jeremy Coller FOREWORD Professor Francesca Cornelli Professor Eli Talmor Issue 8 of Findings commences with an article discussing recent research about CEO contract features governing compensation and Special acknowledgements incentives. The underlying academic paper and comments by and thanks to practitioners highlight how salary and incentive components of CEO Nicole Hergarten-Tucker contracts differ between those applied at public companies and those Professor Eli Talmor Executive director implemented by major PE sponsors at their portfolio companies. It Coller Institute of Private Equity also touches upon how CEO performance is measured and how CEO talent retention features in contractual design. Given the currently Professor articulated concerns about management compensation, what can public Francesca Cornelli companies learn from private equity models and vice versa? With the private equity industry maturing, the number of secondary transactions has grown significantly. A broader range of investors has become active in the buying and selling of LP interests in an evolving PE secondaries market. Anya Kleymenova, Eli Talmor and Florin Vasvari extracted interesting research findings from a dataset representing the PE secondaries activities. This article deals with the question: what are the incentives for supply and demand deepening the liquidity of the secondaries market and what are the key attributes impacting the liquidity of LP interests? Next, Private Equity Findings explores the impact a large investor can have on the strategy and performance of a PE fund. The article asks whether major investors negotiate bespoke terms and impose influence on PE funds, what it means for the other portfolio investors and to what extent this influence has positive or negative effects on the fund. Issue 8’s fourth article uncovers the factors that were critical to one of the most successful transactions in PE history. One of the Coller Institute’s latest case studies provides insights into how PE facilitated the transformation of Nycomed from a pan-Nordic speciality pharma company into a global leader in the pharmaceutical sector. The case study will be taught in forthcoming PE Masterclass programmes at London Business School and demonstrates the importance of choosing a good management team and exploiting opportunities in underserved growth markets. Our unique roundtable article panel, comprising two leading academics and three distinguished industry experts, debates risks affecting private equity investments, the liquidity risk element, the quantification of those risks and how investors manage them. Finally, the discussion turns to whether PE investors benefit from diversification effects in their overall portfolios and the risk-return balance for investors. Published by Bladonmore (Europe) Limited The research paper of the 2012 Coller Prize winner in the PhD category is the topic of the final article. It examines Editor: Vicky Meek the impact of investment horizon on appetite for riskier and more innovative investments in the private equity portfolio context. Furthermore, it investigates relevant impacts on PE fund performance. Editorial director: Sean Kearns As a leading forum for debate and exchange between private equity practitioners and academics, we hope this Lyndon Hayes, Ben Wachenje Lyndon Group editor: Eila Madden edition of Private Equity Findings continues to invigorate thinking and discussion. We look forward to hearing your Group sub-editor: Lynne Densham opinions, which you can email to [email protected]. Portraits: To download the research papers featuring in this issue or to read more about our activities and seminars, please Creative director: Nigel Beechey visit our website at www.collerinstitute.com. Designer: Selena Cardwell Production manager: Andrew Miller Selena Cardwell Publisher: Sharon May Group managing director: Richard Rivlin T: +44 (0)20 7631 1155 Professor Eli Talmor Professor Francesca Cornelli Illustrations: Cover: E: [email protected] Chair, Coller Institute Academic director, Coller Institute spring 2013 | FINDINGS | 3 A round-up of private equity BY THE NUMBERS trends and statistics a re th Ko Asia-Pacific ‘sellers’ thwarting deals Sou The biggest obstacles to private equity investment a re th Ko Sou n Sellers’ high price expectations are the main barrier to getting deals South Korea Japan Australasia India South-East Asia Greater China done in most Asia-Pacific regions, according to Ernst & Young’s Sellers’ valuation Asia-Pacific Private Equity Outlook 2013. The study asked 100 GPs, expectations too high LPs and investment bankers focusing on the region what were the Sellers unwilling to give most significant obstacles to getting deals done. Price expectations up management control came out top in all regions except India, where legal, regulatory and taxation issues ranked higher. Legal/regulatory challenges n The problem is particularly acute in South-East Asia, where nearly 90% of respondents cited high valuations as a major issue. Taxation issues n However, while valuations were the key concern in all but one Cultural or management region, the chart demonstrates the heterogeneity of the Asia-Pacific differences markets: sellers not wanting to give up management control ranked Corruption/compliance second in Japan, and joint second in Australasia and South-East of target Asia. In Greater China, this was far less of an obstacle; legal Sellers do not understand the and regulatory issues were seen as a greater barrier. Meanwhile, benefits of PE investment corruption and compliance is an important issue in Greater China and India, while in South-East Asia this was the least important concern. In South Korea, the obstacles of cultural or management 0-10% 10-20% 20-30% 30-40% 40-50% 50-60% 60-70% 70-80% 80-90% 90-100% 0-10% 10-20% 20-30% 30-40% 40-50% 50-60% 60-70% 70-80% 80-90% 90-100% differences ranked as high as valuations. Source: Ernst & Young % of respondents citing factor as a major obstacle 0-10% 10-20% 20-30% 30-40% 40-50% 50-60% 60-70% 70-80% 80-90% 90-100% Global exit overhang Realised and unrealised capital and dry powder of global buyout funds by vintage year (at 30 Sep 2012) 100% n The economic and market uncertainty that continued into 90% 2012 and beyond is having a clear effect on global PE’s ability to exit. Funds with vintage years 2005 80% to 2008, which saw the highest fundraising values, 70% now account for around two-thirds of unrealised capital in the industry. 60% n With such a high proportion of unrealised value 50% concentrated in the 2005-2008 vintages, distributions 40% from these funds have lagged historical norms by some 30% margin. Analysis