What is Private Equity?
Private Equity (‘PE’) is an alternative investment class that concentrates purely on private companies (i.e. firms that are not publicly-traded). PE firms utilise large amounts of capital (equity and/or debt) to purchase private companies in order to restructure the acquired company before selling them at a higher price. Typically, PE firms will invest in undervalued companies so that its restructuring can increase the company’s intrinsic value. By increasing the share value, these firms can improve their returns when exiting the acquired company. Due to the intricate nature of these transactions, PE deals tend to be long-term investments, in contrast to the approaches typically employed by hedge funds and investment banks.
Common investment strategies within PE include:
The past decade has been one of unprecedented success for the private equity industry. Emerging from the ruins left by the Global Financial Crisis, the PE industry has grown rapidly since the late 2000s in both available capital and the dollar value of PE deals. In fact, PE firms across the world have amassed $1.5 trillion in unspent capital as of 2019, a record for year-end total.
An annual Public Pension study perfectly underscores the dominance of private equity against their investment counterparts – PE deals have provided an annualised return of 8.6% over the past ten years, an entire 2.5% ahead of the following asset class.
The current low-interest-rate environment combined with a lacklustre performance from hedge funds has further pushed investors to private equity in search of higher returns. More recently, investment firms such as Vanguard and Goldman Sachs along with pension funds are allocating funds towards the private capital industry in the search for sustainable yield which has lead to $450 billion USD in deal flow.
To truly understand the nature of PE deals, we turn to Australian Private Equity Firm- Allegro Funds and their investment in the Great Southern Rail (GSR), an Adelaide-based train operator, in 2015. Purchased purely through equity (a 100% stake), the PE firm partnered with GSR’s existing management team to focus on boosting the high-end tourism market.
“It wasn’t the right fit under its previous owner but it had a strong management team in place, iconic assets and was well-positioned to capitalise on the forecast growth of the luxury experiential tourism sector,” Mr Loader (Allegro MD) said in a statement.
Following this acquisition, Allegro analysts worked alongside the GSR management team to improve the performance, and the profitability, of the train operator company. This allowed the PE firm to promptly reduce its investment in the train operator in 2016 with a profitable margin by selling a controlling stake to Quadrant Private Equity.
This deal, whilst insignificant in the grand scheme of investments, perfectly describes the long-term strategy driving PE deals. Unlike short-term investment classes, PE deals are a hands-on business-building task that works intricately with the acquired companies before exiting with significant profit margins.