We recently had a chance to sit down with Martin Okner, best known to us as Chairman of the Association for Corporate Growth (ACG) New York, to get his take on what private equity trends will emerge in 2015.
How do you see the middle market PE landscape evolving in 2015?
2014 was the year of restoration, where new investment paradigms and new ways to think about value across PE portfolios really started to be implemented. There was a lot of figuring things out from 2010 to 2012 as we had a persistent stalemate in Congress as well as significant economic uncertainty. In 2013, we accepted that if uncertainty is the new certain, let us think of ways to create value with that uncertainty overhang. PE firms and strategics began to deploy capital, there was restoration in terms of consumer confidence, and energy pricing continued to come down which gave acquirers a little more confidence. If you look back to 2013, a lot of these dynamics were predicted, so when things began to materialize as anticipated, investors became more confident in paying the higher multiple that good companies were commanding in 2014, and I think that is a theme that will continue through 2015. Now that we’ve seen this model work, I think 2015 will be a year of vitality and we’re going to see more job growth based on the capital deployed in 2014, as well as an increase in deal activity.
I also think the middle market will become a bigger topic in Washington and will create a tailwind for middle market growth going into 2015, due largely to ACG’s effort of public policy and the establishment of the bipartisan caucus for the middle market.
Since the recession, U.S. central bankers have obviously employed a very expansionary monetary policy to underpin growth and development in our economy. Recently we’ve seen the FED wind down its asset purchases (QE), and with rates as low as they are, there is a consensus interest rates will rise over the next year. If and when this occurs, how do you see middle market companies and middle market-focused PE and strategics reacting, especially as rate hikes will slightly increase the price of lending?
I think the effect will be relatively small for two specific reasons:
1: Strategics who are buying middle market companies are doing it largely with cash.
2: PE firms—or at least the core of middle market PE—use very little leverage to buy these companies, so I don’t think that the volatility in the debt markets is going to have as big of an impact in some of the bread and butter and heart of America middle market companies that middle market PE is investing in. I also think there has been enough transparency on the FED’s intention with interest rates, which I think has been priced into a lot of deals as volatility models are run and sophisticated investors have baked these outlooks into their calculations of IRR.
Do you see PE firms taking a less generalist approach over the next year and instead becoming more sector-focused? Further, with many businesses experiencing notable growth in their valuations over recent years, which sectors do you think will continue to outperform through 2015?
It’s interesting; according to our membership survey we have called certain sectors to grow, but when it comes to PE investing, I actually don’t necessarily see a big shift in sector focus for certain firms. What I see occurring is a lot more competition for good deals. I don’t think it will be a scarcity situation like it was two years ago, when basically the good companies commanded a high valuation because there were very few companies on the market. But what I do think is that we’ll see an increased number of competitors bidding for companies in the middle market, which will continue to drive valuations up. However, our ACG New York Membership Survey has called a few sectors winners: the majority feel that technology, healthcare, oil & gas, and manufacturing—as well as consumer companies—will represent a large portion of middle market M&A.
What do you see as the biggest risks or potential downward pressures on middle market PE in 2015?
I think a couple of things will really challenge the capital that is being deployed right now. Even though consumer confidence is better, it is still not at a point where people have fundamentally started buying a lot more, nor have their buying habits returned to pre-recession levels; and consumers still maintain a very deal-savvy focus when they shop. There is a lot of overhang from digging out of the recession, with respect to consumers, and I think the ripple effect really hits all aspects of the economy. This ripple effect will put a lot of pressure on capital that’s deployed in 2015 to really deliver on company growth projections, because it is one thing to be able to strip out costs and create efficiency to generate fuel for growth, yet it’s another thing to actually grow the top line. I think that will continue to be a challenge for private equity firm portfolio companies.
Can you give us some thoughts about the current political environment in Washington, D.C., regarding the middle market and its subsequent relation to PE?
I think that Washington is a city that moves in a very calculated and slow way, but what I think you are going to see this year is a much higher level of consciousness and awareness among policy makers and regulators regarding the importance of the middle market to the U.S. economy. Up until now the middle market never had a voice, however now, with ACG creating a public policy committee comprised of middle market transactional and corporate professionals, this group is able to take a voice down to Washington with documented case study’s from their professional lives, in addition to data that has been generated from the national center for the middle market, as well as ACG’s collaboration with PitchBook for our driving middle market growth website. We represent 44 million jobs in the U.S. and one third of U.S. GDP, and now our voice is a meaningful one to policymakers because we are talking about the businesses that are the beacons of strength for these local communities that our Policymakers Represent.
Do you have any examples of where Washington has made notable positive progress in regards to middle market PE?
Yes. HR 1105, which is the Small Business Capital Access and Job Preservation Act, is a great example of a bill the 113th Congress passed without amendment. Now, while it hasn’t gotten to the Senate yet, it seeks to amend the Investment Advisors Act of 1940 to exempt PE fund investors from registration and reporting requirements, providing that each PE fund has not borrowed and does not have an outstanding principal amount exceeding twice its invested capital commitments. This would eliminate the necessity for PE firms to register themselves and generate the incremental reporting that really increases their cost of doing business significantly.
Featured image courtesy of Wikimedia Commons user Enfo (own work).