Private-market firms increasingly see peers as potential acquisition targets in the race to expand assets under management and the fees they generate. These deals also establish new lines of business and provide a way of expanding into new geographic markets. This mergers and acquisitions (M&A) activity is expected to accelerate considerably when market conditions improve, as more alternative managers go public.
Why private equity is heading for a consolidation
Do as I say, not as I do
The success of private equity has largely been built on its standard practice of buying businesses and selling them for a healthy profit – having steered them through a transitional period of rapid performance improvement. Yet when it comes to applying this successful strategy to their own industry, private-equity dealmakers have proven surprisingly reticent, according to the global consultancy Bain & Co:
‘For much of the industry’s history, consolidation has largely been a nonstarter. Firms have tried over time to expand geographically or add an asset class through M&A. But very often, mergers have foundered on the many levels of integration complexity that arise when private partnerships try to combine.’1
Bain cites a number of reasons why mergers have tended not to work out within the industry. These include culture clashes, compensation issues and a loss of talent when a company becomes a target or is taken over. These difficulties, says Bain, ‘are stubborn enough that most general partners (GPs) simply assume that consolidation makes perfect sense in every industry but their own’. Consequently, the industry has largely relied on organic growth.
Turning point
However, attitudes now appear to be changing, and private-equity firms increasingly see peers as potential acquisition targets in the race to grow, says Bain. The consultancy points to the growing number of deals taking place in recent years.
Figure 1: M&A in private capital has jumped upwards in recent years
Bain’s view is shared by people inside the industry. Christian Sinding, Chief Executive Officer (CEO) of the Swedish private-equity firm EQT, told Bloomberg in June that he could see consolidation on the horizon for alternative asset managers due to fundraising pressures and challenging financing conditions.2
Bloomberg quoted Sinding as saying:
‘There are more than 7,500 private equity firms out there’ and ‘as the industry matures, we will see a major consolidation wave leaving us with a dozen global firms and niche players — the rest will be stuck in the middle’.
Meanwhile, Bain says it expects improved market conditions to unleash a wave of acquisitions as more alternative managers go public from as early as next year.
Familiar pattern
The forces driving consolidation in the private-equity sector are similar to those playing out in the hedge-fund sector – and in other industries, for that matter. Big companies – especially those that are publicly traded – have the financial firepower to fund strategic acquisitions and investments. Private firms, by contrast, have to finance a merger out of the partners’ own pockets, and it can be challenging to acquire private debt to fund deals because private firms are harder to value. So, small firms are often left to focus on smaller deals.
Big firms can also attract the best talent, fund the latest technology and research, and have the resources needed to successfully navigate periods of volatility and economic slowdowns similar to those currently being experienced.
When two tribes go to war
However, there are challenges to private-equity mergers. Perhaps the most important factor to consider is whether the cultures in the two combining forms are compatible. While private-equity firms are good at reading balance sheets and considering all the potential synergies the acquisition of another private-equity firm could bring, they seem less good at analysing the potentially disastrous impact of clashing cultures.
Indeed, finding a good cultural fit is critical ‘because the history of M&A in the private-asset class is not littered with glory. It’s littered with a lot of cautionary tales’, according to Hugh MacArthur, Bain’s chairman of private equity. That is something the private-equity industry should be aware of, given its experience of driving M&A activity in many other industries. According to various surveys, up to 75% of all post-merger integrations fail to meet their original objectives due to cultural clashes. Other problems include underestimating the difficulties associated with moving into new markets and assets.
Over the longer term, however, it seems inevitable that as the industry matures, the recent spike in M&A activity within the sector will continue.
1 https://www.bain.com/insights/is-strategic-m-and-a-finally-catching-on-in-private-capital/
2 https://www.bloomberg.com/news/articles/2023-06-06/eqt-boss-sees-major-consolidation-wave-coming-in-private-equity
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