Private Equity 2019 Forecast and Deskbook On an ongoing basis, Probitas Partners offers research and investment tools for the alternative investment market to aid its institutional investor and general partner clients. Probitas Partners compiles data from various trade and other sources, then vets and enhances that data via its team’s broad knowledge of the market. probity ¯¯˘ n. [from Latin probitas: good, proper, honest.] adherence to the highest principles, ideals and character. Probitas Partners is pleased to present its Private Equity 2019 Forecast and Deskbook. The purpose of this paper is to offer our forward view of likely trends for 2019 and beyond, based on our review of 2018 and our ongoing dialog with (and surveys of) the global institutional investor marketplace. The paper starts with our forecast for this year, then presents a summary review of the dominant trends that shaped 2018 and the details behind those trends. We encourage you to obtain copies of our research reports, surveys, and deskbooks from our firm’s library at www.probitaspartners.com. Contents Private Equity Outlook ........................................................... 2 Private Equity Deskbook .......................................................... 6 Fundraising ................................................................................ 6 Deal Volume and Capital Overhang .................................. 14 The Buyout Market: Investor Focus and Concerns ......... 17 U.S. Venture Capital .............................................................. 22 Distressed Private Equity...................................................... 26 Asia ............................................................................................ 30 Europe ....................................................................................... 34 Emerging Markets ................................................................... 36 Private Debt Markets ............................................................. 38 Real Assets ............................................................................... 42 The Secondary Market ........................................................... 44 Co-Investments ........................................................................ 46 Conclusion ............................................................................... 49 © 2019 Probitas Partners Private Equity 2019 Forecast and Deskbook 1 Private Equity Outlook Heightened Focus on Risk Institutional investors are — and have been for some time now — worried that we are reaching the top of a market cycle. This is especially true in the buyout market where high purchase price multiples, high leverage, and record levels of “dry powder” becoming an increasing percentage of the mergers & acquisitions market that is characterized by aggressive competition between buyout funds and strategic acquirers create “Fear of a greater investor concerns about heightened risk. Investors’ fears are not, however, limited to the buyout market. Direct lending funds are increasingly coming market moving up the risk spectrum in search of returns, and the use of covenant-lite structures across private debt deals are also of concern, as is the dramatic cycle has increase in leverage utilized by secondary fund managers in purchasing secondaries transactions. not caused There remains no consensus on what the trigger for, or the timing of, investors to a market turn will be. Investors have been overtly concerned about the risk of a market turn for the last three years, but few have a strong opinion on cut back on what might flip the markets. But there is concern that besides the underlying market fundamentals, the fear that global political risk may have significant their pace of economic impacts is increasing. commitment to Distressed private equity: A hedge for the coming market cycle? In the past, distressed private equity funds have been used by certain investors private equity concerned about a coming market cycle to moderate impact on their buyout portfolio exposure. Though there is always a degree of opportunistic timing dramatically.” in distressed private equity investing no matter what is going on with the overall economic cycle, a recession usually generates a surge of stressed and distressed opportunities. However, many limited partners have become more cautious about the sector based on their experience with the prior cycle. The forecast for a “100-year flood” of distressed opportunities driven by the Great Financial Crisis (“GFC”) was washed away by the wave of central bank liquidity that was pumped into markets globally. Some investors seek to time the opportunity — and today, based on fundraising in the sector, the majority appear to be of the view that the time has not come yet. Investors remain focused on the need to deploy capital in a market where most alternatives feel fully priced. Fear of a coming market cycle has not caused investors to cut back on their pace of commitment to private equity dramatically; they continue to balance their fears with the need to deploy capital to maintain their investment exposure to a market with relatively few attractive alternatives. In this regard, the steep decline in North American buyout fundraising in 2018 seems to be market noise rather than a clear signal as fundraising for the first two months of 2019 is back to 2017’s breakneck pace. Six mega-buyout funds seeking $10 billion or more are currently in market. At this point, 2018’s fundraising dip seems more likely to have been a temporary gap between two peaks of mega-buyout funds in the market and not a wholesale market retreat. The need for dry powder going into a down cycle. Experienced investors realize that though falling markets will hurt the private equity portfolios recently placed on their books, they need to be ready with dry powder to take advantage of falling purchase price multiples when the Private Equity 2019 Forecast and Deskbook © 2019 Probitas Partners 2 market turns — so long as those new commitments are to fund managers that have investment bandwidth and are not overwhelmed by legacy investment issues. Interest in China Not Matched in Other Emerging Markets Outside Asia Even in the face of trade conflicts with the United States and concerns about its economy, interest in China remains strong. The headlines for China over the last few years have highlighted such issues as slowing economic growth, increased strategic tensions with its neighbors and the United States over the South China Sea, and trade tensions with the United States. What has not been as obvious, perhaps, has been the continued interest in private equity fundraising for funds focused on China as well as Pan-Asian funds with significant allocations to Greater China. A quick look at the tables in this report that detail the ten largest funds raised globally for buyouts, growth capital, and venture capital make clear the global interest in China. This focus is also driving a growing interest in South East Asia as a related market positively impacted by the Chinese economy and a “Large lower-cost alternative to Chinese export production... investors are ...although this is not the case generally for emerging markets. While interest in private equity in China and Asia remains strong, interest increasingly in Latin American and African-focused funds has remained weak over the last three years. In 2018, the largest U.S. dollar-denominated fund raised making to focus on China, Hillhouse, raised nearly twice as much as was raised for all Latin American and African private equity. As far as Russia, which has very large been increasingly unpopular with Western private equity investors due to perceived political risk, the market was unable to raise a single third-party commitments fund in 2018 and the suit against Baring Vostok launched in February 2019 to a smaller further hurt its already tarnished reputation. number of Diverging Interests of Investors in Their Approach to the Market the largest Large investors versus small investors. Large investors are increasingly making very large commitments to a smaller number of the largest funds in funds in order order to increase their leverage with certain managers and in turn develop strategic relationships. Typically, they are also pursuing co-investments, fund- to increase linked separate accounts, and broad separate accounts. Additionally, these large investors are often major investors in long-dated funds or separate their leverage accounts that have begun to be raised over the last three or four years by the largest fund managers who seek to tie up capital commitments for extended with certain periods. These long-dated vehicles are meant to serve the needs of certain large pension plans and sovereign wealth funds looking for exposure that managers and matches their long-term liabilities. in turn develop This approach by large investors gives them an advantage in accessing co-investments that can lower their average cost of investing and provide strategic greater strategic insight into the market — but it is an approach that is difficult for smaller investors to replicate, especially with larger funds. It also relationships.” has the potential to put smaller investors at odds with larger investors when key issues are reviewed by Limited Partner Advisory Committees (“LPACs”). The largest investors typically dominate a fund’s LPAC, and some smaller investors are becoming concerned that their interests may not be adequately represented.