2017 served as a sizable inflection point for us on the analyst team at PitchBook. We’ve typically focused on publishing core flagship research reports across private equity, venture capital and M&A, which you likely are familiar with (hopefully). These include our PE Breakdown, Venture Monitor and M&A reports.
As we transitioned out of 2016, however, we made a point to add research that sat closer to the themes and trends that were developing in our clients’ businesses. This was initially an experiment, yet as we continued to hire and develop the team, we’ve concluded 2017 with nearly 30 pieces of thematic research across PE, VC, M&A and fintech.
I took some time to go over all the research we’ve published this year and have profiled some of our top ideas and themes below. I hope you find this insightful and helpful in your practices and we look forward to penning a lot more next year!
Is the risk worth the wait?
Examining risk-adjusted returns for various private market strategies over a 12-year period (between 2000 and 2012), we find that venture capital funds in our sample have performed worse than all other strategies studied. VC funds during this period exhibited a median IRR of 5.1% with a standard deviation of close to 17%. We find that PE buyout and distressed debt funds display the best risk-adjusted returns, with buyout funds returning a median IRR of 12.4% and a standard deviation of just under 18% during this period, while distressed debt vehicles have returned a median IRR of more than 10% and a standard deviation of 11%.
Feels like the first time
First-time PE funds have made a resurgence in recent years, driven by the broader exuberance in private market fundraising. In fact, first-time vehicles in 2017 accounted for nearly 10% of all fundraises, which is nearly double the 5.6% figure we saw in 2013. For context, however, first-time managers represented nearly 23% of all PE capital raised in 2009. Against a backdrop of intense limited partner interest for private market exposure, we expect first-time fundraising to continue growing in the near term as such managers have outperformed follow-on funds. For 2012-2014 vintages, first-time managers have produces a median IRR of 17.1%, compared to 10.8% for follow-on vehicles.
Opportunities in Japanese private equity
We see significant opportunities for PE to capitalize on changing dynamics in Japan, primarily driven by attractive relative valuations and a changing culture around capital allocation. Despite record high corporate profits, EV/EBITDA multiples for publicly traded Japanese companies sit at 7.9x, as opposed to 11.9x for US public companies. Given a historically less competitive M&A environment in Japan, we hypothesize that there might be an even wider variance between public and privately held companies in Japan relative to the US or EU.
Further, Japan’s corporate governance has historically placed less emphasis on enhancing shareholder value and, as a result, many Japanese companies are bloated with poor capital allocation strategies. However, recent regulatory and governance reforms are providing potential opportunities for PE firms to streamline operations, divest non-synergistic lines of business and greatly expand margins.
Venture’s liquidity release valve
The current state of extended hold periods and delayed VC-backed exits continues to push investors to search for alternative liquidity solutions. We expect the venture direct secondary market to continue evolving and become a more prominent presence within the scope of venture capital. The direct secondary market represents an attractive liquidity option, allowing some investors, founders and/or employees to realize their stakes without requiring a complete exit. Further, the access points available to utilize such transactions (e.g., exchanges and brokerages) have continued to grow, which will only sustain continued maturation in the direct secondary market.
A breakdown of initial coin offerings
We expect to see further implementation of various decentralized business models that have taken advantage of the relative ease of raising capital via non-dilutive token sales (ICOs), which attracted over $4 billion in 2017. These token sales have displaced venture capital as the primary funding source of early-stage blockchain projects, which in comparison raised a little less than $1 billion YTD through mid-December. Risks can be prevalent here as many retail investors lack a long-term fundamental approach to trading and investing in crypto assets. However, we continue to see Ethereum as one of the most favorable crypto investments. In our view, Ethereum remains a leveraged play on ICOs in general since so many utilize the protocol for funding and execution of smart contracts. If more ICOs continue to proliferate, Ethereum will simply benefit from continued use to help power various ICOs.
Brazilian banks set for disruption
Brazilian consumers are currently saddled with the world’s third-highest borrowing costs. Further, 71% of lending in the country is provided by five of the largest banks in Brazil. The lack of competition has made Brazilian banks highly profitable with consumer lending rates sitting around the roughly 50% APR mark. In addition, many Brazilian SMEs have been largely shut out from credit markets as these primarily state-run institutions have targeted lending to mainly multinational corporations.
This strategy stems from a desire to gain access to foreign currency deposits and revenue streams in a country with a long history of hyperinflation. The egregious interest rates charged by the incumbent banking monopoly, along with the lack of access to credit, has created an opportunity for alternative lenders and credit card issuers. We believe alternative lenders that can leverage technology to offer consumers more attractive rates and a better user experience have an opportunity to gain market share from politically influenced incumbents.
No longer secondary concerns
Despite significant and consistent growth in recent years, we believe the LP secondary market has significant room for continued expansion driven in part by an anticipated rise in niche secondary funds. In fact, 2017 has already set a record with more than $34 billion raised across 18 secondaries vehicles, with an average fund size of $1.8 billion. Further, much of this rise will be driven by what we see as a shift by LPs to locate new access points to PE. This has been reflected in not only the rise we’ve seen in secondaries, but also the rapid decline in FoF fundraising, which fell to the lowest level since 2003 this year.
Publicly traded private equity underperforms peers
Publicly traded PE stocks have underperformed a number of broad indices. However, as we examined the returns of these publicly traded shops against their private counterparts, we found a couple different tales. First off, publicly traded PE firms outperform their privately held counterparts over the medium and longterm. LPs at The Blackstone Group, Apollo Global Management, The Carlyle Group, KKR and Oaktree have experienced a 15-year horizon IRR of 12.38% compared to 10.33% in the rest of the industry. We also find similar—albeit less pronounced—outperformance on a 10-year and five-year basis.
Second, we found that the five largest privately held PE firms outperform the publicly traded ones in terms of IRR on every time horizon, suggesting that firms—and by extension their LPs—may be at a disadvantage by going public. These firms include TPG, Bain Capital, Lone Star Funds, Advent International and Providence Equity Partners.
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Moving forward, we'll continue to focus on publishing the most differentiated, actionable and useful research for our clients and readers. We've already profiled some of our predictions and outlook for 2018, which you can see here.