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Kevin Schmidt Of Debevoise On Private Equity: The Repeal Of Dodd-Frank, Deal Trends, And PE's Future

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The private equity market has shown attractive returns for decades, especially in comparison to the public markets. 2016 faired quite well, with funds delivering 6% end-to-end pooled IRR, compared to 4% for the S&P 500. Of course, along with attractive returns comes closer scrutiny from regulators and intense competition, which is fueling complexity and challenges that are changing the shape of the industry. Slowly but surely the relationships between GPs and LPs are changing, in turn shifting where money is coming from, and where and how it is being invested. To better understand the trajectory of this, today we hear from Kevin Schmidt, Debevoise & Plimpton’s co-head of private equity. We broach the future of the asset class, trends outside of LBOs, active near-term investments, and more. Please see below for a revised version of our exchange.

 

On The Future Of Private Equity As An Asset Class

Parnell: Can you talk to me about the future outlook for private equity investment? What is its future as an asset class?

Schmidt: Given the impressive returns of private equity over many years relative to other asset classes, the future outlook continues to be bright. It is true that IRR may be impacted due to fierce competition for M&A deals, which has increased purchase price multiples; and the leverage lending guidelines have in many cases required increased utilization of equity funding rather than debt; but the industry, as always, has adapted. We’ve witnessed the increased number of longer-term-hold funds, with different return expectations. And the current willingness to look beyond traditional leveraged buyouts to identify special situations, such as PIPE investments or unique opportunities in industries suffering dislocations – particularly in the energy sector – are evidence of this.

On Deal Trends Outside of LBOs

Parnell: We are seeing a number of trends arising on the landscape due to the performance of the class. Can you give me an example of a recent deal trend you have observed outside of traditional LBOs?

Debevoise & Plimpton

Schmidt: We have seen an increasing number of PE sponsors backing or partnering with SPACs, which are blank check public companies used to pursue M&A opportunities. TPG [Capital] has set up two of them, as has Riverstone [Holdings]. We just worked on a deal for Blackstone in which it is joining with a SPAC called CF Corp to take private Fidelity & Guaranty Life. If the SPAC completes a deal, it offers the PE sponsor – and the SPAC investors – a completely flexible holding period. Also, the management team of the acquired company has the prospect of running a public company immediately upon closing, which can be attractive. So, we expect to see more deals involving private equity and SPACS going forward.

On the Most Active Near-Term Investments

Parnell: What types of investment do you think will see the most interest in the near term?

Schmidt: In addition to energy, which I mentioned, tech is white hot. The valuations are high, but PE investors continue to believe the business fundamentals, particularly in software, will be more resilient to a downturn than other businesses. You also continue to see private equity increasingly looking at the insurance and insurance services sector. We have found that in our industry.

On the Roll Back of Dodd-Frank

Parnell: Do you think that the administration will be successful in rolling back Dodd-Frank? And if it is, how will this affect private equity?

Schmidt: Notwithstanding the CHOICE Act that was passed in the House, the prospects of sweeping legislative reform seem unlikely in the near term.  Attention seems to be turning more to the regulatory agencies rather than Congress as many changes can be made through regulatory action. As the administration has more appointees in place at the agencies, the pace of change may pick up.  From the perspective of private equity, we note that the Treasury issued a report this month recommending that the leverage lending guidance be re-issued for public comment and suggesting moving away from a strict 6x leverage test. Also, the administration is due to issue reform recommendations on asset management activities and that report will provide more insight on PE specific issues.

On Private Equity’s Competition for Investment Money

Parnell: What kind of competition for investment money is PE looking at, right now? For example, corporate acquirers looking to put cash to work for themselves, or the IPO markets, or LP shadow capital, etc. Will PE continue to receive higher allocations over the next year?

Schmidt: Competition from strategic buyers has been particularly strong. Corporates are facing increased challenges to achieve growth organically and M&A provides an attractive alternative to achieve this end. Additionally, traditional private equity has been facing competition from alternative capital pools – including sovereign wealth funds, non-US pension plans, and family offices – that have moved into the direct investing space. These alternative capital pools historically limited themselves to passive co-investment roles in deals, but in recent years they have ramped up hiring of investment professionals and are willing to step up to take leading roles on transactions. Five or ten years ago, you would have seen larger deals completed by consortiums of three of four PE sponsors. But today, you often see a single sponsor teamed with a sovereign wealth fund or pension plan to complete a deal.

On Changes in The PE Legal Sector

Parnell: How are the changes in the PE market affecting the legal sector? Have you seen a consolidation in the number of firms being used by the funds, for instance?

Schmidt: There is no question that some sponsors are seeking to rationalize the number of law firms they use to achieve efficiencies resulting from common practices that can be carried over from deal to deal. On the other hand, given the number of sponsors that operate multiple funds with different investment strategies – such as credit, mezzanine, specific geographic focus – and the number of deals that require particular sector expertise, we have experienced strong growth in new private equity client opportunities. Our experience in insurance, healthcare and telecom, media and technology, coupled with our track record in the sector since its early days, have been particularly helpful in gaining recent M&A mandates. Also, we find that private equity clients look for firms such as ours that have a full complement of practice groups that demonstrate our commitment to servicing the industry. This includes white collar enforcement and regulatory expertise, and the recent return to our firm of Mary Jo White and Andrew Ceresney from the SEC.

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