Three Little Letters Will Dominate Private Equity
In an article published in the Australian Financial Review, Michael Bruun shared his views on the evolution of private equity return expectations and the importance of cash returns in the current environment.
The long drought in private equity deals has investors asking to see cash returns, says Goldman Sachs’ co-head of private equity. Michael Bruun, the global co-head of Goldman Sachs’ $US186 billion ($281 billion) private equity franchise, says investors in the sector (known as limited partners) are sending a clear message to firms: show me the money.
“Don’t talk to me about the returns that you see in the books, talk to me about the cash that you can return to me,” is the way the London-based Bruun sums up the mood in the sector right now.
Private equity firms have previously liked to spruik their multiple on invested capital (typically expressed as “we made X times our money”) or their internal rate of return (which is an estimate of the value of future cash flows).
But the new focus in the industry is on a metric called DPI, which is shorthand for distributed to paid-in capital. In layman’s terms, it’s the ratio of cash paid back to limited partners to capital invested.
The focus on DPI is understandable given the deal drought that has set in since the heady days of 2021, when private equity deal volume peaked at $US2.2 trillion; last year, volumes fell to $US1.3 trillion.
Private equity exits fell 25 per cent from 2022 to 2023 to $US574 billion, which inevitably flowed through to the amount of cash returned to investors.
According to investment bank Raymond James Financial, distributions to LP stood at 11.2 per cent of funds’ net asset value in 2023, the lowest since 2009, and well below the median figure of 25 per cent of the past 25 years.
Bruun emphasises that the deal market is in recovery mode, and the typical deal tension between trade buyers, strategic buyers and the IPO market is still nowhere near as strong as it was during the pandemic years, albeit there are signs of life around IPOs, particularly in the US.
But he argues pressure to improve DPI is a key reason to expect the deal drought to start to ease this year – more private equity firms will simply need to do deals to be able to return cash to their LPs.
“We think that there will be a lot of focus on people who are able to monetize their assets,” he says during an interview in Goldman’s Melbourne office. Bruun believes Goldman Sachs is well-positioned to come through a period of dispersion in cash returns in good shape for several reasons.
First, the firm’s private equity franchise did well exiting investments in and around that 2021 deal peak in deal volumes, and so has been able to be choosy about more recent asset sales.
Second, while deal markets have been difficult recently, the operational performance of portfolio companies – which in Australia includes the cancer care business Icon has held up well. This has meant they have been able to grow into their valuations in the past few years, and will come to market as stronger businesses.
Third, Bruun says Goldman Sachs’ private equity arm has a strong track record in exiting investments via trade sales, which he expects should hold up reasonably well in the recovering deal environment.
The ability to execute trade sales, Bruun says, comes down to Goldman Sachs’ biggest advantage in private equity: the sheer size of its global network.
Given Goldman Sachs’ private equity funds are backed by a combination of traditional LPs, the Goldman balance sheet and capital from Goldman staff, Bruun says there is strong alignment between the private equity division and the rest of the firm.
Bruun and his team very deliberately tap this network to support portfolio companies by finding potential customers, deepening supplier relationships and, as you would expect from one of the world’s biggest investment banks, finding both potential acquisitions targets and potential acquirers.
Goldman Sachs’ recent acquisition of a Norwegian education technology group called Kahoot, which was taken private in January for about $US2 billion, is a good example of this.
This week, Kahoot appointed former BT Group CEO Gavin Patterson, who told the Financial Times that he had been connected to the company after working with Goldman’s investment bank for 20 years. It’s an example of deal plus network equals stronger portfolio company.
Bruun is also confident of Goldman’s track record in growing the earnings of portfolio companies, which he says will become more important for LPs in the current environment. He says firms cannot rely on the growth in multiples they’ve seen in the past, and higher interest rates will make it tougher to growth cash flow via deleveraging.
Goldman has formalised the process of growing EBITDA through a program it calls its value accelerator.
Under the program, about 100 operating advisers – many existing Goldman staff, but some from outside the firm – help portfolio customers in six main areas: scaling revenue; operation excellence; talent, technology (particularly digitisation and artificial intelligence); sustainability; and financing.
“Doing all that’s fantastic, but then combining it with a network – that’s where the real magic happens,” Bruun says.
