What is private equity?
A private equity fund is a pool of cash set up for corporate investment. The fundamental concept of private equity is to buy a business – with a decreased leverage of around 50% equity stake – and to provide equity infusion, technical know-how, strategic direction and leadership to allow it to quietly flourish for a few years. The fund then sells through an initial public offering (IPO) or a sale of trade, making an excellent return for its investors.
The fund manages to raise equity from limited partners (LPs) which may include endowments, pension funds, corporate funds, high net worth individuals (HNWIs) and fund-of-funds. General partners (GPs) handle the LPs’ cash and supervise the fund’s day-to-day activities, make investment choices, and handle the purchased businesses (also known as portfolio firms).
Globally, there is plenty of unused capital available with PE funds (commonly referred to as ‘dry powder’). Their ticket sizes can range from USD 500 million, sometimes going as high as USD 3 billion per investment. Private equity funds with dry powder are generally found in US and Chinese markets.
The Australian private equity market
Private equity investment companies in Australia turn over an estimated $63.5 billion annually, contributing to the economy around $58 billion in total value added, along with employment for 512,000 full-time equivalents. If private equity investor companies were a sector on their own, their income would exceed coal mining or the general insurance sector, and they would directly hire more individuals than the automotive or banking industries.
Over the past decade, private investment has risen twice as fast as public markets. Private markets now have a market value of more than USD 6 trillion – nearly 10% of global investment assets.
Trends in the Australian private equity market
We expect the following developments to shape the year ahead based on our assessment of the Australian economy and conversations that we had with industry professionals:
- Mergers and acquisitions (M&A) – It is anticipated that private equity and deal activity will contribute to a robust M&A market in 2019. Local funds will seek to deploy record amounts of dry powder after a strong fundraising year, resulting in intense rivalry for quality deals.
- Economic conditions to affect portfolio choices – While the Reserve Bank of Australia (RBA) is unlikely to increase interest rates until 2020, high household debt levels, low wage development and dropping house prices are likely to affect consumer spending. This will have a negative effect on valuations and interest in businesses that are exposed to the discretionary industries of consumer and property investment. Private equity funds holding portfolio companies in these industries may delay exits until the economic climate becomes more favourable or accelerate plans for trade sales before expenditure further softens.
- Privatisation to continue – In 2019, local and international private equity interest in public-to-private opportunities will continue with a number of targets already listed in ASX fielding offers from private equity suitors. Large Australian funds like BGH Capital and Pacific Equity Partners with plenty of dry powder will compete for more significant private take-off possibilities, while smaller and mid-market funds are likely to explore the tiny and medium-cap opportunities.
Key favourable sectors to watch in 2019
In 2018, sectors such as food and agriculture, healthcare and business services saw the highest level of private equity engagement. While these traditional favourites continue to be shared in 2019, the conversations that we had with private equity funds show that the following are the industries to be watched in the coming year:
- Aged Care – ‘Buying and building’ strategies are anticipated to play a role as there are many single facility operators in the aged care industry that could be consolidated to benefit from economies of scale. An instance of this strategy was the roll-up of 44 aged care centres by Archer Capital to form Allity, now Australia’s fourth-biggest residential aged care supplier in the private sector.
- Internet of Things (IoT) – The combined IoT markets are anticipated to expand to $520 billion by 2021, which is more than twice the amount invested in 2017 (according to Bain & Company).
- Healthcare – In 2019, M&A activity in the healthcare sector is anticipated to stay stable and private equity funds will play a leading role. Private equity buyout activity will be twofold:
- Targeting purchases of both listed and non-listed healthcare assets that operate cash-generating businesses with growth potential;
- Investing in healthcare portfolio businesses to capitalize on multiple elevated purchase prices paid by strategic acquirers.
- Business Services – A powerful track record, high-quality repeat customer income and the capacity to scale features on the shopping list for private equity firms. One fund that has recently capitalised on this chance is Mercury Capital, which has purchased a stake in a marketing and communications company called MessageMedia.
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This article is intended for general discussion and is not intended to represent specific advice. Banks Group shall not be responsible for any entity that acts on any of the comments in this article without first obtaining specific advice from Banks Group.