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©2013 TorreyCove Capital Partners
Table of Contents
A Macroeconomic Overview
Buyouts 12 U.S. 18 Europe
27 Distressed Debt 32 Mezzanine 35 Secondaries
41 Venture Capital
Select Emerging Economies 46 Asia (China + India) 57 Brazil
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A Macroeconomic Overview
Developed markets stabilized and even staged a muted recovery in some cases on the back of European Central Bank actions to contain the euro and sovereign debt crises and continued U.S. Fed easing policies. The prospects for a continued improving trend in Europe and the U.S. remain under threat from structural imbalances, fiscal consolidation, and deleveraging in the former, and continuing inaction on the fiscal front with respect to the latter. Emerging markets, though slowed in 2012, still undergird global growth, as they have since the crisis erupted in 2008. In the face of persistent policy dithering and economic headwinds, as well as the never-ending catalogue of geopolitical crises, most equity markets performed well in 2012, a trend that is likely to carry momentum into 2013, as interest rates reach a structural bottom and as less riskaverse investors shift portfolios to stretch for yield.
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important elections (particularly in Germany and Italy). according to Eurostat.1% during the third quarter of 2012. followed by Sweden at an estimated 0. Household formation. effective implementation of the outright monetary transactions program by the ECB. real GDP increased at an annual rate of 3.3% during the third quarter of 2011. and house prices are on the rise and should be a driving force in 2013. and fiscal consolidation will present important challenges to the restoration of business confidence and resumed economic expansion. GDP Growth 15% 10% 5% China United States Western Europe 0% -5% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E Source: IMF © 2013 TorreyCove Capital Partners | 4 .1% during the third quarter of 2012 compared to 1.4% compared to the third quarter of 2011. government spending. Increases in inventory investment.A Macroeconomic Overview 2013 Outlook Economic Growth U. France’s recent downgrade. homebuilder equities. Overdue infrastructure investment and increased energy development should also increase growth and job creation. European GDP increased by 0. at 0. Of the largest European economies. the U.5% growth over the third quarter of 2012.3% during the previous quarter and 1. short. according to the Bureau of Economic Analysis. residential investment. had the strongest GDP growth quarter-to-quarter. but fell 0.K.9%.to medium-term growth rests heavily with policymakers as markets concentrate heavily on fiscal issues. and exports drove the quarterly growth and were partially offset by decreased nonresidential investment. However.S. Going into 2013.
© 2013 TorreyCove Capital Partners | 5 . The annualized third quarter growth rate was 7.4 to 34. and the number of discouraged workers decreased 8.2 million while average weekly hours worked by all employees in the private sector slightly increased from 34.0 thousand. Outside policy shifts. Chinese GDP grew 2. but remains high relative to the pre-recession low of 274.1% to 909.8 million from 5. Many believe Chinese growth has begun to shift downward somewhat from the 10% annual rates of prior years. Japanese exporters including automakers have recently benefited due to the weakened yen as well as improving overseas economies.0% going into 2013 and beyond. The probability of growth rebounding to prior heights is reduced in the face of decreasing private investment and manufacturing over-capacity.5% to 8.3 trillion and somewhat less aggressive actions from the authorities to boost growth.8% as of December 2012.8% growth rate during the year. Japan’s GDP contracted by 0. which can be seen in the unemployment rate.A Macroeconomic Overview 2013 Outlook In Asia. Economic uncertainty persists. in order to mitigate deflation. The number of workers unemployed for 27 weeks and over fell to 4. given the economy’s size of approximately $8.7% on a year-over-year basis. Preliminary results for 2012 indicate a 7. The Japanese government and the central bank formed an unprecedented agreement to target 2% inflation through asset-purchases during 2013.9% compared to the second quarter.S.6 million year-over-year. Unemployed civilians decreased from 13. but has somewhat abated from last year. During the third quarter of 2012. China’s growth will most likely stabilize around 7.0 million to 12. unemployment decreased 70 basis points from 8.2% during the third quarter of 2012 according to the Bureau of Statistics of China.5% as of December 2011 to 7.0 thousand in December 2006.5 hours during the period. Unemployment U.
8% in November 2012. Unemployment Rate U. Germany (5. Unemployment Rate 25% 20% 15% 10% 12% 10% 8% 6% 4% 5% Spain Greece Portugal Ireland Euro area Italy France Sweden U. respectively. seven decreased. China and Japan both experienced 4.6%) and Greece (26. Among the member states.5%). eighteen states’ unemployment rates increased. the lowest rates were in Austria (4.9% followed by India which reported 3. Within the EU27.A Macroeconomic Overview 2013 Outlook The Euro area reported an unemployment rate of 11. Asia continued to exhibit low unemployment rates.6%). The highest unemployment rates persist in Spain (26. Finland Denmark Belgium Canada Germany Australia Netherlands Luxembourg Austria Japan 2% 0% 0% Source: Trading Economics Source: Bureau of Labor Statistics © 2013 TorreyCove Capital Partners | 6 .S. and the Netherlands (5. Luxembourg (5.K. U.1%).0%).1 million unemployed civilians on a year-over-year and quarter-over-quarter basis.8%. representing increases of 2. up from the prior year’s 10.0 million and 0. The South Korean unemployment rate was the lowest at 2.4%). and two were relatively flat when compared to 2011.S.6%.1% unemployment rates.
1%). and 1. Global Inflation Rates 10% 8% 6% 4% 2% 0% -2% -4% 2002 2003 2004 European Union US China 2005 2006 2007 2008 2009 2010 © 2011 2012 Source: Eurostat.0%) and household energy (1.6%.5% during 2012. housing (3.5% decrease in November.1%).5%). Within the food index. while the lowest inflation rates were for communications (-3.7%. the lowest inflation rates were observed in Greece (0. National Bureau of Statistics China 2013 TorreyCove Capital Partners | 7 .1%). the items that declined were used vehicles (2. down from the prior year’s 3.0%). and recreation & culture (1. Sweden (1.0% in December 2011 to 1.7% in December 2012.3%).3% in December 2012. December was flat.2%). 1. Romania (4. For the year. the gasoline index declined in each of the last three months of 2012. Four of the twelve months in 2012 experienced deflation and after a 0. housing. respectively. during the year.4%). Food.8%.6%). household equipment (1.6%). five of the six groups increased during December. and France (1. Geographically. The energy index increased 0. The EU annual inflation rate was 2.8%).6%).0%. and gas prices increased 1. and the highest in Hungary (5. when energy prices increased 6.0%). The highest annual rates were recorded in alcohol & tobacco (3. However. food and education (both 3.A Macroeconomic Overview 2013 Outlook Inflation Inflation in the United States slowed in 2012 as the annual change in the consumer price index fell from 3. which represents a strong deceleration from 2011. and Estonia (3.7%.
some officials indicate the purchase program may discontinue by year-end 2013.K. fresh vegetables increased 14. In September. Due to market sentiment.A Macroeconomic Overview 2013 Outlook China’s annualized inflation rate was 2. the program’s establishment reduced Spanish and Italian bond yields without actually purchasing Central Bank Rates 12% 10% 8% 6% 4% 2% 0% Canada Turkey France Indonesia 2010 2011 2012 Brazil U.6% and markedly down from last year’s 4.5% in December 2012.S. In December. Food prices increased 4. the Federal Reserve committed to $40 billion and $45 billion of monthly purchases of MBS and long-term Treasuries until unemployment rates drop. and has more than tripled since 2008 in its effort to keep rates low and stimulate a weak economy.6%. the European Central Bank established an open-ended bond purchase program to alleviate borrowing costs in troubled nations including Spain. However.6% and residential prices increased 3. Gasoline prices increased 2. Of the various food groups.0%.2%. near the 10-year average of 2. Euro area Source: Trading Economics © 2013 TorreyCove Capital Partners | 8 Russia China . Sovereign Banks The Federal Reserve’s balance sheet broke through $3 trillion for the first time in history in January 2013.8% and fresh fruit decreased 5.1%. Germany South Korea Australia Japan India Italy U.
respectively.94 trillion. Last year. Public Markets Returns 500 400 300 200 S&P 500 MSCI Emerging Mkt DAX 30 Russell 3000 ® FTSE 100 VIX Index 300 250 200 150 100 100 0 Source: Bloomberg 1 50 0 2011 Source: Bloomberg 2012 Russell Investment Group is the source and owner of the trademarks. Interest rate spreads are down across the region. Historically volatile money market rates should stabilize as the PBOC becomes more flexible. the PBOC cut reserve ratios in February and May. service marks and copyrights related to the Russell Indexes. the equity markets did well in 2012. Public Markets Despite slowed economic growth in both developed and emerging markets.A Macroeconomic Overview 2013 Outlook bonds thus far. The change marks a slight migration toward the typical tools used by other major central banks. The European Central Bank’s balance sheet decreased €150 billion from its peak in June and currently stands at €2. This year the PBOC will most likely rely more on open market operations. and lowered benchmark interest rates in June and July. pointing to subsiding fear and returning confidence as most investors agree the worst has passed. © 2013 TorreyCove Capital Partners | 9 . Russell® is a trademark of Russell Investment Group.4%. The S&P 500 and Russell 3000®1 returned 16% and 16. marking a solid year that was still outpaced by the German DAX Index which rose 29. Compared to last year. volatility measured by the VIX Index decreased.1% for the year. The People’s Bank of China (“PBOC”) recently enacted new short-term liquidity measures. supplementing its current market operations.
Similarly in Europe. falling buyout firms have been using more leverage on deals and average debt multiples have approached pre-crisis levels.4%. Depending on successful policy change. Election results in Italy may unravel the reform achieved by the current Monti government. However. Japan’s focus on a targeted inflation rate through open-market purchases to combat deflation should boost growth. Europe’s economy is expected to modestly recover to 0.4% growth in 2013 from -0. which will add financial stability. The EU held together during 2012 and most believe the worst of its recessionary pains have passed.0%. but weaknesses in the developed markets will negatively affect demand. peripheral issues may attract less attention as Washington focuses on fiscal consolidation. However. Emerging markets are expected to grow 5.S. the elections may slow decision-making in Europe. Advanced economies are expected to grow 1. global growth may support Europe’s weaker nations as they continue to adjust to austerity. according to the IMF. Elections in Italy and Germany will also impact the region’s recovery. increasing uncertainty. including U. leading to increased risk appetite as investors desperately hunt for yield. homebuilder equities.1% in 2012. U.2% in 2012.S. Bottomed interest rates have heated the high yield market. leading to economic stability. Chinese GDP is expected to modestly increase to 8. The key risk will be effective implementation of the recently established Outright Monetary Transaction (“OMT”) process. growth of 2. Inflation trended down and is expected to decrease further before reverting closer to its 10 year mean just above 2%.S. U. stimulus could be transitory absent medium-term fiscal reform. Likewise. from 5. with debt costs.3% in 2012. Change in policy has strengthened growth.0% in 2013. Tangentially. household formation. © 2013 TorreyCove Capital Partners | 10 . and house prices are on the rise and should be a driving force in 2013.5% in 2013 from 3. overdue infrastructure investment and increased energy independence would also increase growth and job creation. China’s growth depends on shifting the economy toward private consumption. political stalemate and fiscal drag will continue to influence volatility.A Macroeconomic Overview 2013 Outlook The Outlook for 2013 World output is projected to increase to 3. In Germany.5% in 2013.
such as regional or sector weightings. Mezzanine. medium-term growth trend remains in place. export weakness. especially in North America. low default rates. inflation fears reduced but not gone. expectation of some dynamism returning to buyout space MODERATE UNDERWEIGHT Special Situations Distressed Debt. reform efforts stalled. sector. and improving U. For this reason. objectives. reduced inflation fears. inflation still relatively high. These are guidelines. tightness in pricing expected to persist Venture Capital > page 41 Exit markets open after strong 2012. improved exit markets European Large Buyouts > page 18 Much-improved situation regarding sovereign debt and Euro crises. continued Fed accommodation. competitive environment for debt creates pricing pressure SECONDARIES > page 35 Reduced selling pressure globally. a client may pursue an investment with a top-performing investment manager even when a region. + Secondaries > page 26 DISTRESSED DEBT > page 27 Strong dynamics within debt markets.Tactical Summary Ratings are tactical recommendations and assume a portfolio with a stable strategic allocation Buyouts > page 12 SMALL ($500 Million and Below) and MIDDLE MARKET ($500 Million to $5 Billion) 12. more favorable valuations ASIA > INDIA > page 54 MODERATE OVERWEIGHT NEUTRAL NEUTRAL India: Reduced growth. but still expecting strong year for deal flow. and some export weakness BRAZIL > page 57 Sub-optimal macroeconomic growth picture. decreased valuation of Brazilian currency It should be noted that TorreyCove’s private equity portfolio management methodology emphasizes the equal or greater importan ce of manager selection in relation to other elements of the portfolio management process.to 18-month commitment outlook > Relatively stable investment and exit activity slightly lower leverage at small end LARGE ($5 Billion and Over) MODERATE OVERWEIGHT NEUTRAL Rebounding deal flow and investment activity. an institution’s weightings may differ based on their current portfolio composition and overall goals.S. visibility needed on next major trend(s) NEUTRAL Select Emerging Economies > page 46 ASIA > CHINA > page 51 Resuming growth trend. economy MEZZANINE > page 32 NEUTRAL MODERATE UNDERWEIGHT NEUTRAL Improving buyout deal flow and reduced equity contributions. or strategy is deemed less attractive on a relative basis. © 2013 TorreyCove Capital Partners | 11 . continued balance in supply/demand of capital. Positive factors: demographic medium and longer-term growth. and risk tolerance.
it is much more in line with the sustainable trend over the past decade and should balance well with expected market supply/demand over the next few years. 2012 was a bit of a disappointment. when they were a meager $14B. energy and power was once again highly favored. Investment Activity Capital deployment by buyout shops remained steady in 2012.Buyouts > U. with about 43% of the total. putting the year just short of the healthy level seen in 2005. While middle-market funds ($1B to $5B) were still the largest gatherers of commitments for the year. proving that the recovery of the sector that began in 2010 has legs. In terms of strategy. with sub-$1 billion funds taking in a healthy $30 billion in 2012. Meanwhile. Overall. commitments to mega funds (over $5B) more than tripled from 2011.S.S. mega and large buyout funds accounted for a material portion of the increase in committed capital during the period. with a poor first quarter ($12 billion deployed) costing it a chance to equal the Average Debt Multiples of Large Corporate LBO Loans Purchase Price Multiples Senior Debt/EBITDA Equity/EBITDA Sub Debt/EBITDA Others 7 6 5 4 3 2 1 0 2000 Sub Debt/EBITDA SLD/EBITDA Other Sr Debt/EBITDA FLD/EBITDA 10x 5x 0x 2011 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 4Q12 Source: S&P Source: S&P 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 4Q12 © 2013 TorreyCove Capital Partners | 12 . In comparison to its predecessor. Fundraising This past year also marked the return of the mega buyout fund. In 2012. buyout and mezzanine fundraising came in at approximately $154 billion for 2012. While this is about 50% off of the 2007 peak. buyout strategies appeared to have finally broken out of the relative torpor that had engulfed them for much of the post-crisis period and most measures of activity were in a strong uptrend for the year. they were far less a factor than in 2011. U. when they accounted for over two-thirds of the total. shifting the balance of fundraising back to the larger side of the market where it traditionally resides. In fact. The smaller end of the market remained steady.
Buyouts > U. quarterly investment totals were running within striking distance of 2011’s quarterly totals. In terms of investment activity. at least when one looks at the number of deals.76 125.S. identical to the amount for LBO Funds Raised By Target Size Through 2012 ($B) 200 2007 2008 2011 2009 2012 U.S. instead coming in close to 25% lower. which has served to inflate asset values. when multiples exceeded 10x EBITDA. the U. The abundant availability of very low cost debt and remainder of the capital overhang that must be burned-off by buyout shops round out the most important factors putting a relatively high floor under buyout deal pricing.17 150 100 50 0 4Q 3Q 2Q 1Q 2010 313.00 34.” Purchase price multiples for deals showed no sign of moderating in 2012.46 158. prior year’s activity. and the higher level of risk tolerance exhibited by investors in today’s market.46 Mega Funds ($%B or more) Large-Medium Mid-Market funds Funds ($300M to $999M) ($1B to $4. with two of the most impactful being Fed monetary action. We do not anticipate a major change in this dynamic over the next 18 months. compared to even two years ago. the highest level other than at the peak of the boom. Purchase multiples are being supported by a variety of factors. to just over 9x EBITDA (all buyouts).38 167. –Based Disclosed Deal Value By Quarter 700 600 500 400 300 200 100 0 603. The stickiness of purchase multiples holds through nearly all deal sizes (especially those over $250 million).99B) Small funds (up to $299M) 2005 2006 2007 2008 2009 2010 2011 2012 Source: Thomson Reuters.19 167. with only the smaller end of the market showing signs of a moderation in the steady rise that has been in play since the end of the postcrisis recession.S. indicating that there is not a significant downtrend in terms of capital deployment. Exits Buyout funds put in a fairly decent year with respect to exits. However. and in fact ticked up slightly from last year’s level. over 440 buyout-backed companies were exited through the M&A channel. For 2012. buyout space remains a “seller’s market. Buyouts © Source: &P Capital IQ M&A Stats December 2012 2013 TorreyCove Capital Partners | 13 . with a total value for disclosed deals (165) of $70 billion.05 91.
As it turned out. Outlook Last year at this time. Buyouts > U. One factor that may lead to a somewhat lower fundraising take in 2013 when compared to last year is that most of the mega buyout funds have closed. and stable. when the deal count was nearly the same (455). investment. We expect a decent fundraising year for buyouts in 2013. Most importantly. leaving the middle market to take up the slack. Investment activity should pick up appreciably as the market puts fear and risk aversion further in the rear view mirror. We expected the M&A exit route to hold steady. and we expect a more supportive environment for exits will develop over the next 12 to 18 months. Small and Middle Market 12. Overall. nearly double the number from 2011. active. The IPO route opened up somewhat. or are about to close.Buyouts > U. and it did. we anticipated a relatively steady year for the buyout asset class in terms of fundraising. On the investment front. leading to © 2013 TorreyCove Capital Partners | 14 . each of the past two years has seen significant improvement from the relative freeze of 2009. Large 12. primarily due to the entry into the market of several large buyout funds. due to the increasing private equity allocations of large institutional investors over the past few years.S. while the IPO exit route showed some signs of additional life. the fundraising numbers were much stronger than what we had expected. at or near the levels seen in 2012.S.to 18-month commitment outlook > STRONG OVERWEIGHT MODERATE OVERWEIGHT NEUTRAL MODERATE UNDERWEIGHT STRONG UNDERWEIGHT Buyouts > U. as well as a renewed willingness on the part of investors to take risk. but not robust.S. which we now think of as closer to the “normal” state for the asset class. a trend that is likely to continue as return expectations for other asset classes remain flat or in decline. we were generally correct that 2012 would remain in a stable state compared to 2011. and exits. the exit environment for buyout companies last year is best characterized as open. as 40 buyout-backed deals found their way onto public exchanges in 2012.to 18-month commitment outlook > STRONG OVERWEIGHT MODERATE OVERWEIGHT NEUTRAL MODERATE UNDERWEIGHT STRONG UNDERWEIGHT 2011.
and abundant financing availability. corporate cash stockpiles are increasingly likely to find their way into M&A transactions. increased animal spirits on the part of investors and buyout funds alike.. A modest reduction in the capital overhang (if it occurs) and stronger deal flow (also a possibility) are not likely to put much downward pressure on purchase multiples in the light of the strong macro factors setting a floor under price. secondary buyouts will continue to present a viable option for buyout shops to get deals done. Fueling the entire sector will be the continued provision of easy. cheap debt financing. This will be aided by continued strong pricing dynamics and the more aggressive stance of the buyout sector. as large and middle market firms seek to deploy the last of their commitments from prior funds before they expire. courtesy of the Fed. should prove resilient for a time in 2013.S. especially in the U. • Secondary buyouts.Buyouts > U. Until deal flow picks up further.S. accounting for 61% of global secondary value and representing a post-crisis high for this exit route (Source: Preqin Private Equity Spotlight October 2012). already having gained considerable steam in the past year. © 2013 TorreyCove Capital Partners | 15 . which already appears to have generated some momentum in 2012. it is more likely to be to the upside. increasing interest from strategics. The stage is also set for an uptrend in the exit environment for buyouts. If any change is to occur. underpinned by increasing competition amongst buyout investors. To illustrate. as well as the ever-present low cost financing. North American buyout shops completed $34 billion worth of secondary deals in the first three quarters of 2012. Some key factors relating to the North American buyout sector over the next 12 to 18 months are as follows: • Purchase multiples will remain near the levels seen in 2012. Now that markets are feeling increasingly confident that the risk of a major collapse is further in the distance.
By contrast. providing about 5x EBITDA in total debt most recently. the highest reading for all but two of the past 15 years. first lien debt is actually slightly higher within the middle market.Buyouts > U. However. Breakdown of Aggregate Secondary Buyout Deal Value by Region 100% 80% 60% 40% 2006-Q3 2012 Asia and Rest of World North America Europe 20% 0% 2006 2007 2008 2009 2010 2011 Jan-Sep 2012 Source: Preqin Buyout Deals Analyst © 2013 TorreyCove Capital Partners | 16 . We assume very little downward pressure on debt multiples for 2013. first lien debt steadily ratcheted upward to its current level. first lien debt fell to near 2x before beginning its rise. in the prior recession.S. these trends are not anticipated to abate significantly.5x EBITDA. at least for the larger transactions. first lien debt. at approximately 4x EBITDA. which was recently hovering just below 4x EBITDA – where it peaked at the height of the bubble – never collapsed the way it did in the prior recession. Interestingly. one of which was 2007 (6. After falling somewhat close to 3x in the aftermath of the financial crisis. the return of pre-crisis leverage levels has recently been accompanied by some other notable practices from that era. • Leverage levels associated with buyouts have returned to within striking distance of the levels last seen in the bubble era.2x). Overall multiples as of the fourth quarter of 2012 stood at 5. including “covenant-lite” loans and dividend recaps. • In a related vein. Middle market lenders are only moderately more cautious than their large market colleagues. So long as leverage is freely available. given the highly accommodative monetary policy maintained by the world’s central banks.
• The valuation trend for buyout fund portfolio companies should bias upward.” An upward trend for both segments is expected for 2013 with respect to investment. buyout activity should pick up in 2013 and managers are expected to shift somewhat into a more risk tolerant posture. macroeconomic performance improves. • With sub-par but stable growth in North America and the Euro crisis at bay until further notice. valuation. due in part to the large number of large and middle market funds on the fundraising trail. We expect 2013 to continue this trend. perhaps displacing the energy sector as the darling of the buyout asset class. Our tactical rating for the small and middle market buyout sectors remains “Moderate Overweight. as well as improving market conditions. and we continue to expect a further rationalization of the manager universe. and macroeconomic conditions in the important North American region. with marginal performers and many less-established funds dropping by the wayside. • The preference of large institutional limited partners to cull the ranks of their private equity portfolios has not abated. © 2013 TorreyCove Capital Partners | 17 .S. as the M&A markets remain steady. and exits.Buyouts > U. barring a major disruption that saps economic confidence. and the IPO markets show some life (though nothing like the past glory days). • The industrial sector in North America is expected to become more attractive to buyout shops in 2013. exit opportunities. growth is expected to become a more prevalent theme (as opposed to downside protection) on a relative basis. Our tactical rating for the large buyout sector is moving from “Moderate Underweight” to “Neutral” based on improving deal flow. • The past two years have seen a return to a more “normal” pattern for distributions to limited partners (for funds of the 2004 through 2008 vintages). Therefore.
However. which are presumably representative of a more sustainable fundraising environment. The first half of 2013 should give a better sense of which. Nevertheless. for perspective. European buyout strategies raised €76 billion. A relatively strong fourth quarter for investment could indicate a return of some semblance of optimism. In total. with fundraising and investment flows remaining at generally quiescent levels for much of 2012 in comparison to the last year. a renewed enthusiasm by value investors. 2012 fundraising was very much in line with the levels seen in the post-crisis period and the third improvement in as many years. indicating that demand for buyout investing in the region has at least established stability and is clawing back year-by-year. as the market appeared to test the newfound stability in the euro currency dynamic. driven substantially by the closing of a few established large funds such as Advent GPE VII (€11 billion) and BC European IX (€7 billion). Fundraising 2012 posted a modest increase in fundraising by buyout funds year-over-year.Buyouts > Europe European buyouts had a generally unremarkable year. © 2013 TorreyCove Capital Partners | 18 . a meaningful increase of 13% over 2011 levels. this amount was still less than half of the peak fundraising years just prior to the financial crisis and still significantly below 2005 numbers. or simply a false dawn.
However. Meanwhile. the large/mega segment came back to life to an extent in 2012. the UK saw its deal value nearly triple from the third quarter. In particular. in spite of a stagnant deal count. driven once again by a few large cap transactions. in comparison to the third quarter of 2012. In fact. as deal value – propelled by a flurry of late-year mega deals – bumped up to over €22 billion (82% quarter over quarter). the investing appetites of buyout shops operating in Europe appears to have increased on the margin. both generating substantial increases in deal value during the fourth quarter. © 2013 TorreyCove Capital Partners | 19 . the full-year totals for buyout investment activity still came in below the past two years.Buyouts > Europe Investment Activity In total. the environment for deploying buyout capital in the EU still presents significant headwinds. It is too early to make a guess as to whether this is the beginning of a more sustained recovery in investment activity. value ranged from approximately €12 billion to €15 billion over the first three quarters. or simply a blip within a more stagnant trend. Given that 2010 – 2011 were not blockbuster years themselves. but one that was punctuated by a fourth quarter that showed some real signs of life. After a decent first quarter showing in terms of buyout deal volume. the fourth quarter of 2012 more or less saved the year. accounting for over one-third of total value for the year. In terms of deal size range. as the hangover from the most recent eruption of the Euro crisis in late-2011 hung on. on both deal count and value. By region. buyout volume settled into a midyear slump where volume traded in the 90s. while the middle market and small market segments slipped somewhat. What can be said is that. where the number of deals broke 100 and rebounded from a poor figure in the fourth quarter of 2011. 2012 will go down as a rather disappointing year for buyout deal making. with the latest installment of the currency crisis increasingly in the past. the UK and Nordic regions came away winners.
approximately one-third of what was generated in 2011. always a relatively popular way to exit in the European buyout space. The trade sale/M&A route also declined. Secondary sales.Buyouts > Europe Exits European exit markets were less than accommodative in 2012. with the IPO route still effectively closed to most private equity companies. itself a less than stellar year. as cash-rich strategic players and more aggressive private equity shops look to capitalize on value opportunities in the EU. While the number of deals exited via trade sale was only slightly off from 2011. with 2012 only about €1 billion off from 2011s €18 billion. Volume and Value of European Private Equity-backed Buyouts Volume Value (€bn) 160 140 120 100 80 60 40 20 0 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Source: Q4 2012 unquote” Private Equity Barometer © 35 30 25 20 15 10 5 0 2013 TorreyCove Capital Partners | 20 . The outlook for a major opening of the public markets for European deals remains muted for 2013. in both number and amount. the total value of such deals declined by approximately €13 billion. In 2012 there was a handful of IPOs of PE-backed companies generating just over €1 billion in proceeds. the prospects for substantial increases in both trade sales and secondary sales are much brighter than for IPOs. Given a marginally improved and more stable current macroeconomic situation in Europe. held up much better. from 2011 levels. or over 50%.
the ECB’s extension of low-cost liquidity to the banking sector via its three-year term loan program. real GDP growth for the core European countries remains poor. © 2013 TorreyCove Capital Partners | 21 . projections for real GDP growth for the Euro area (17) are more or less flat for 2013 (0.0% growth). The periodic euro currency and sovereign debt crises that roiled the continent since 2010 were tamed. Even the better performers like Germany saw a difficult year in terms of growth. Germany slipped under 1% for 2012 and is not expected to break that threshold in 2013. Whether intentional or not. On that front.and longer-term prospects for the EU economies. due to the major structural problems which continue to bedevil the region despite the temporary removal of the more immediate Euro crisis. coupled with Mario Draghi’s statements that effectively “talked down” the emerging runs on peripheral sovereign debt. the picture is still not terribly pretty. France and Italy. Some of the trends and issues that should figure meaningfully in EU markets over the next couple of years are described below: • As noted earlier. the markets are now paying attention to the medium. have fared even worse and are both expected to underperform the average in 2013 and 2014. The region’s second and third largest economies. While not necessarily a solid consensus view yet. though 2014 may see reasonable growth resume. Overall. with even some of the more resilient economies faltering. the EU has shown little traction in terms of GDP growth. as their trading partners within the EU experienced recession/slow growth and austerity. With the immediacy of the euro and sovereign crises in abeyance. a substantial body of market opinion is predicting a “lost decade” scenario for the Eurozone countries. had the effect of quelling bond market anxiety and putting the European banking system on somewhat better footing early in 2012. at least for a time.to 18-month commitment outlook > STRONG OVERWEIGHT MODERATE OVERWEIGHT NEUTRAL MODERATE UNDERWEIGHT STRONG UNDERWEIGHT Outlook In 2012.1%) and 1. After a reasonably good year in 2011 (3. by the actions of the European Central Bank.4% for 2014. After a recessionary year in 2012.Buyouts > Europe 12. the focus in Europe shifted from fear to one of relatively stable gloom.
primarily as a result of the retention of earnings and secondarily as a result of capital raises. Also.4 -0. in a report released in January 2013 by the EBA. these major banks have increased capital cushions by a reported €116 billion or more and the larger EU banking system by over €200 billion.Buyouts > Europe • While it would be unwise to say that the European banking system as a whole is wellcapitalized. Deleveraging was not a material factor.4 0 -5 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Eurostat © 2013 TorreyCove Capital Partners | 22 . there was definite improvement within the sector in 2012.4 0.4 -4. Since then. median Tier I capital ratios were reported as having increased from approximately 11% to nearly 12% over the course of 2012. the system’s largest institutions were under orders from the European Banking Authority to boost capital by well over €100 billion and many were practically shut out of the interbank lending markets.1 1. Around this time last year.2 3 2 0. We would add that the “Draghi carry trade” appears to have been a major contributor to these improved capital ratios.4 1. European Area GDP Growth Expectations 5 3.
The actions of the ECB have effectively bought major banks some time and flexibility with which to clean up their balance sheets. this should prove a headwind to economic growth across the region. • The state of affairs in the European financial system point to a continued credit shortfall on the continent. middle and small market enterprises will continue to find the lending window either shut or significantly diminished. citing the gingerly treatment given to dodgy sovereign debt assets (Spain and Greece) in the calculation as well as other “loopholes” afforded to banks in Europe that are not extended to other international institutions (Source: BIS). as banks continue to limit risk by curtailing lending in certain areas and deleveraging. the Bank of International Settlements took issue with a recent report by consultant Oliver Wyman on the new capital requirements for the Spanish banking system. In a specific case. Taken in aggregate. • Probably the best way to characterize the European banking situation at the beginning of 2013 is stable and modestly improved in terms of capital adequacy. Annual Senior Loan Volume € Billion 1Q 2Q 3Q 4Q DEAL COUNT 140 120 100 80 60 40 20 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 320 280 240 200 160 120 80 40 0 Source: S&P M&A Stats © 2013 TorreyCove Capital Partners | 23 .Buyouts > Europe • Of course there are informed market participants that are more than a little skeptical regarding these capital ratios. While large enterprises will continue to obtain financing at reasonable terms and sovereign debt issuers will find a friendly banking system willing to purchase their debt. but the pressure to do so is not likely to go away. indicating that the €76 billion euro total was probably only half of the ultimate requirement.
as heavily-constrained economies like Italy. • There is no recovery for IPO markets in sight in 2013. © 2013 TorreyCove Capital Partners | 24 . but this is not expected to be a major improvement. this knocked its GDP down severely. • Deal flow is likely to increase on the margin. Greece. Overall. Secondary buyouts will continue to be an important exit route for Europe-based deals and is likely to accelerate as investment activity by buyout firms increases. As the bulk of Germany’s trade is inter-EU. with the UK and the Nordic regions showing the most heat. sending it down to a near-recession level for the year. • There was little change in terms of leadership in the private equity investment arena from 2011 to 2012. A continuation of this trend for at least the duration of 2013 appears the most reasonable assumption. the prognosis for the private equity asset class (emphasis on buyouts) in Europe will be similar to that of the beginning of 2012. This situation is expected to improve modestly by 2014. as financial institutions build capital. Further.Buyouts > Europe • As expected. this phenomenon is expected to be limited to the larger end of the commercial scale. the problems of the EU periphery found their way into the core during 2012. the environment should be opportunistic and value-oriented and the momentum for larger deals that began in 2012 should carry into 2013. as deleveraging still beckons and risk aversion remains high. Spain. Value plays should outnumber growth plays. • With some exceptions. but M&A should remain steady. due to their relative insulation from the currency and sovereign debt crises. The key trends should be as follows: • The availability of leverage is likely to open a bit. The primary difference will be the absence of the scythe of a currency crisis hanging over the region. at least for the time being. while rescue situations may be more common. as investors infer lower risk in the EU compared to a year ago. and others provided less demand for goods from Germany and other stronger countries. but 2013 is set to be another relatively flat year for growth.
and expanding investment in Europe-related high-growth economies like Turkey. There is no reason to assume anything near traditional European growth levels of prior years coming to pass in the near term and the case is not too good for the medium term. while not even near top form. These factors include fiscal austerity. which bodes well for value-oriented private equity investors. so private equity investment in the EU should show a meaningful rebound in 2013. slow-moving structural reforms. © 2013 TorreyCove Capital Partners | 25 . • In terms of the most advantageous private equity investment strategies. has made some progress in addressing its capital problems. there is substantially more stability in the region than at this time last year. much of the cure for what ails it (or at least the medicine that is being prescribed) is likely to cause substandard economic growth for years to come. purchasing attractive assets from deleveraging financial institutions. and persistent uncertainty as to the longer-term prospects and pathway to further integration of the EU and Euro zone. the situation is more stable at present and immediate major risks of a collapse have been disposed. Our tactical rating for European large cap buyouts is moving from 2012’s “Strong Underweight” to “Moderate Underweight” for 2013. still look to be sound strategies. much of the game plan from last year remains. a continued curtailment of credit for certain important sectors of the economy.Buyouts > Europe • The investment levels seen in the fourth quarter of 2012 are likely the beginning of an uptrend rather than a blip in a downtrend. but against a perceived lower-risk backdrop with more visibility on growth (or lack thereof). Unfortunately for the EU. While the debt and currency crises have most likely just been deferred and not solved. The banking system. In spite of this. Focusing on taking advantage of the credit hole.
with both fundraising and investment of capital extending the momentum from recent prior years. The next year or two should turn out to be substantially more robust for mezzanine strategies than those directly after the crisis. After some years of difficulty due to reduced deal flow from the buyout sector and “over-equitization” transactions by buyout investors. Fed’s easy money policy and quantitative easing have effectively reinflated the debt markets and saved the day for all but the worst enterprises. default rates have remained at very low levels in recent years. 2013 promises to be yet another good year. With a slowdown in deal flow nowhere to be seen and an aggressive posture by secondary managers. © 2013 TorreyCove Capital Partners | 26 . The U. After a brief spike. all of which indicate that the prospect of making excess returns in the space has probably become marginally less viable. along with falling equity contributions. Secondary strategies put together yet another exemplary year. Distressed strategies have been waiting for a massive debt market dislocation ever since the crisis hit – a dislocation that never really materialized. especially on the investment side. the mezzanine strategy looks to be on a better footing at the beginning of 2013. However. the market for large transactions has been relatively efficient. and the supply of capital to secondary strategies has increased substantially. making life quite difficult for distressed investors trying to turn a profit. With buyout deals coming back briskly and leverage levels reaching heights last seen before the crisis.Special Situations Overview The prospects for special situation strategies shifted appreciably in 2012. pricing has remained stubbornly high.S. mezzanine appears to have found its place in the world again.
but relatively strong. 2005-August 2012 70 60 50 40 30 20 10 0 Europe Asia Rest of World 2005 2006 2007 2008 No. we do not anticipate a major shift from North American dominance of distressed fundraising. we expect 2013 to prove another solid year on the fundraising front. the strategy settled into a steady. investor sentiment for the distressed space has shifted on a relative basis to a more Euro-focused stance (see nearby graph). the strategy saw a steep drop-off in fundraising in 2009. or nearly one-third of the total (due almost entirely to the closing of one large. However. established fund during the year).Special Situations > Distressed Debt Fundraising After a blowout 2008. As expected. In terms of fundraising. Therefore. fundraising trend over the next two years. the story is one of high investor demand and a relatively constrained supply. when it raised between $25 billion and $30 billion in each year. 2012 is currently on track to post a fundraising total for distressed strategies that will rival 2010 and exceed 2011. once investors regained some confidence in private equity. but Europe should play a strong secondary role for the next few years. Given investors’ stated positive attitude toward distressed investments and the number of funds in market. and European-oriented managers posted a strong 2011 fundraising total of nearly $8 billion. Investors’ Geographic Preferences for Distressed Private Equity Funds. of Funds Raised Aggregate Capital Commitments ($bn) 2009 2010 2011 Jan-Aug 2012 Source: Preqin © 2013 TorreyCove Capital Partners | 27 . Benefiting from this momentum. October 2012 90 80 70 60 50 40 30 20 10 0 Noth America Source: Preqin Annual Distressed Private Equity Fundraising. when approximately $57 billion was raised for distress-related funds.
could trigger a wealth of deal flow for distressed investors. there is not too much new to report. and Sino-Forest ($1 billion). Eastman Kodak ($1 billion).5 billion). But compared to one year ago. ATP Oil & Gas Corp. economy.. There have been only a handful of meaningful defaults in 2012.1 billion). what with the recurrent fiscal showdowns and shifting tax structures in the U. high yield default rate. and the never-ending saga of the euro. the prospect of a slowdown in the developed world is ever-present.50% only once in the last 11 quarters (Altman) and came in most recently at 0. which has been above 0.S. ($1. strong high yield and leveraged loan markets. the prospects for attractive deal flow and aggressive deployment of capital have dimmed for distressed firms. the improving U.S.5%) and continued liquidity provision at the longer end of the bond markets.24 %. and the relative ease with which decent companies can obtain refinancing. including: Residential Capital ($3. High Yield Default Rate Straight Bonds Only 14 12 10 8 6 4 2 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 (3Q) Source: Altman & Kuehne High-Yield Bond Default and Return Report © 2013 TorreyCove Capital Partners | 28 . Of course. the investment prospects for distressed fund managers would have to be seen as more limited. consider the quarterly U. the Fed has created a monetary environment in which only the worst companies can fail. With respect to the drivers of this state of affairs. or some that are not foreseen. the Fed is probably the biggest culprit making life difficult for distressed investors. As evidence.S. With its statement indicating zero or near-zero interest rates through at least 2014 (or until the unemployment rate drops to below 6. Other factors that are contributing to the effective ceiling on the default rate include: large and growing cash balances on corporate balance sheets.Special Situations > Distressed Debt Investment Activity Compared to one year ago. Either of these dynamics. As noted over the past couple of years.
(Source: Altman and Kuehne High-Yield Bond Default and Return Report November 2012). At the present time.Special Situations > Distressed Debt 12. distressed strategies witnessed the trend moving away from them in some significant respects. Due to its nature as an opportunistic investment class that thrives on market dislocation.to 18-month commitment outlook > STRONG OVERWEIGHT MODERATE OVERWEIGHT NEUTRAL MODERATE UNDERWEIGHT STRONG UNDERWEIGHT Distressed Debt Outlook After appearing to be poised for a breakout a little over one year ago. the market is estimated at $1. Percentage of New High-Yield Issuance Rated B.6 trillion. as different factors are moving in different directions.or Below Based on the Amount of Issuance 60% 50% 40% 30% 20% 10% 0% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: S&P’s Global Fixed Income Research © 2013 TorreyCove Capital Partners | 29 3Q 2012 . defaulted and distressed debt market was estimated at $1. Most recently. its highest level since 2008. forward-looking projections for distressed strategies are always somewhat difficult. the situation is particularly fluid with respect to these strategies. While some of this is due to reclassification.S. Some of the more important factors – most of which are negative (bullish for distressed strategies) – are noted as follows: • In late-2011. much of it results from the general decline in distress levels in the debt markets. the U.3 trillion.
high yield issuance through the third quarter of 2012 was about $239 billion ($186 billion for first nine months of 2011) and leveraged loan issuance of $116 billion was more than double the comparable period in 2011. also showed significant easing during 2012. One of the better demonstrations of the new willingness of investors to take on risk is provided by the strength of the public debt markets. companies have used the opportunity afforded by the Fed to refinance at extremely low rates and push out upcoming maturities further.Special Situations > Distressed Debt • Another useful measure of distress. On the supply side.0%.S. or near-record issuance in the past several months. (Source: Altman and Kuehne High-Yield Bond Default and Return Report November 2012) • Through the third quarter of 2012. After straying into the red zone in the third quarter of 2011 (22% versus an average of 15%). the ratio of high yield bonds trading at or above 1. High Yield High Yield Issuance ($B) Default Rate 300 250 200 150 100 50 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 3Q 2012 20 15 10 5 0 Source: Fitch Ratings © 2013 TorreyCove Capital Partners | 30 . In the context of the current economic environment. such low default levels are highly unusual. Treasuries. close to 1% each. U. all of this coming on top of what was a solid year for public debt in 2011.000 bps over comparable U. this measure moderated considerably in the subsequent year. the trailing 12-month default rates for both high yield bonds and leveraged loans maintained very low levels. ending the third quarter at 11.S. Driven by intense investor demand for yield (and a willingness to stretch to get it) debt markets have obliged with record.
and the Euro crisis periodically breaks through to dominate economic events.S. if and when it emerges. or a major shock from the EU – have not changed. The primary headwinds to the strategy are Fed policy and steady (though substandard) growth in the U. fundraising for distressed strategies continues at a rather robust pace. U. These elements. economic performance is slowly improving. while keeping distress at bay for the foreseeable future.S. with about 23% of issuance rated below investment grade through the third quarter of 2012 (average of past five years of 29%). economy. Therefore. the increasing volume of high yield securities issued over the past two years is likely to serve as kindling for the distressed opportunity. and continued “all in” posture of the Fed in providing liquidity and maintaining a historically low cost of capital. we expect an excellent opportunity for the strategy within the next three to four years. In the meantime. but believe the likelihood of such an opportunity over the next 12 to 18 months has lessened. only to be quieted with another temporary fix. which has been accompanied (and probably caused) by an increasing investor willingness to snap up these issues. are likely to increase the magnitude of distress once a triggering event occurs. a quiet environment waiting for a crisis to ignite a strong run for distressed investing. © 2013 TorreyCove Capital Partners | 31 . In most respects.Special Situations > Distressed Debt The quality of high yield issuance appears to have remained relatively consistent and in line with historical averages over the past few years since the crisis (in 2007. fiscal front (punctuated by highlypublicized political battles that ultimately end up with less than durable fixes and erode market confidence). the environment for distressed strategies has not changed appreciably from the beginning of 2012.S.S. Our tactical rating for distressed strategies is being moved from “Moderate Overweight“ to “Neutral” given the increased availability of high yield debt. about 50% of issuance was Bor lower).S. stasis prevails on the U. However. The Fed maintains a very accommodative monetary policy. And so the outlook for distressed strategies is much the same as last year: in general. The likely actors in this drama – a budget crisis in the U. One thing that has changed is the acceleration of the issuance of high yield securities. improving U.
after a depressing 2009. and through.Special Situations > Mezzanine Fundraising and Investment Mezzanine strategies appear to have found a steady state in terms of fundraising in the more recent post-crisis years. In fact. These amounts are quite consistent with the pre-crisis years leading up to. The rebound of buyout deal making over the past couple of years – the lifeblood of most mezzanine investment funds – has had a salutary effect on the asset class in terms of capital deployment. 2005 (the bubble years of 2006 through 2008 saw commitments of $20 billion to $30 billion in each year). mezzanine strategies returned in force. mezzanine funds have garnered at or near $10 billion in commitments for each of the past three years ending in 2012. After a difficult year in 2009 (along with most other private equity strategies). with 2010 coming close to equaling the previous best year of 2006. Annual Mezzanine Fundraising 2003-2012 | $ Billion $35 $30 $25 $20 $15 $10 $5 $0 2003 Source: Thomson Reuters 2004 2005 2006 2007 2008 2009 2010 © 2011 2012 2013 TorreyCove Capital Partners | 32 . while 2011 and 2012 powered past this high water mark. 2012 has already solidified its status as the best year in the last ten by this measure. At close to $3 billion deployed.
in lock step with the improving prospects for the buyout asset class. • The high liquidity environment fostered by the Fed. this should indicate a further tightening of pricing for most. as the “overequitization” trend for buyouts appears to have run its course. the structure of buyout deals in the current market favors further deployment of capital by mezzanine funds. a meaningful reduction from the 40% plus amounts that were common in the first couple of years after the crisis. meaning equity contributions for many buyout deals are now well within the 30% to 35% range. Salient points relating to this and other issues affecting the mezzanine space are noted below: • We expect fundraising to hold at or near the 2012 level over the next couple of years. mezzanine investors. however. are exerting meaningful competitive pressure on all debt providers. especially within the larger end of the market. with more potential for greater fundraising due to improving dynamics for the buyout industry in terms of increased deal activity and thinning equity contributions relative to the immediate post-crisis years. if not all. In general. For example. no-call provisions have experienced pressure as many BDCs have been willing to provide mezzanine capital without such protections. • As touched on earlier.Special Situations > Mezzanine 12. along with the strong high yield markets of the past year. including mezzanine. there has been some weakening of covenants. The case for outperformance for the 2013 and 2014 vintages is not as easily made. • In a related vein. © 2013 TorreyCove Capital Partners | 33 .to 18-month commitment outlook > STRONG OVERWEIGHT MODERATE OVERWEIGHT NEUTRAL MODERATE UNDERWEIGHT STRONG UNDERWEIGHT Mezzanine Outlook The prospects for mezzanine funds with respect to fundraising and capital deployment are expected to trend in a favorable direction over the next 12 to 18 months. due to competitive pressures.
Deal pricing pressures are the major concern with respect to this asset class.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Thomson Reuters © 2013 TorreyCove Capital Partners | 34 . we continue to expect that mezzanine funds that can operate in the smaller end of the market.0 $0.S.0 $1.Special Situations > Mezzanine • In general. due to the high levels of total debt being placed on companies in today’s market (see U.” with an expected increasing trend in terms of capital deployment. We would add that those mezzanine firms with positive and long-standing relationships with high quality buyout shops should experience less in the way of deal flow shortages and severely-restricted pricing.0 $2. pursue non-sponsored deals. Our tactical rating for mezzanine strategies is moving to “Neutral” from “Moderate Underweight. Sum of Equity Invested 2003-2012 | $ Billion $3. the risk borne by mezzanine providers has also increased.5 $1. but as noted above.5 $2. So the trend for the mezzanine strategy will be in the direction of maintaining pressure on pricing and covenant protection for the near future. • As noted in last year’s Outlook. certain firms will be able to at least partially mitigate this pressure. or develop more customized solutions will have more pricing power and find attractive deal flow more abundant.5 $0. indicating the returns to the strategy for deals made in 2013 may be lower than usual. Buyout section for a discussion of leverage levels). while the environment for deployment of mezzanine capital has improved.
when about $20 billion was transacted. Annual Secondary Fundraising $ Billion AGGREGATE COMMITMENTS NUMBER OF FUNDS Secondaries Deal Volumes $ Billion 30 25 25 20 15 10 20 15 10 5 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 5 0 2006 2007 2008 2009 2010 2011 2012 Source: Preqin Source: Coller Capital. given that most of the same drivers are in place and to much the same degree. making 2012 the second best year on record. Though next year is likely to be another good fundraising year. with $25 billion in total transactions closed during the year. it should be somewhat down from 2012. Both years go down as the most active periods. the post-crisis years have been very good to secondary funds. After two years that raised $10 billion each. Dow Jones. Investment Activity Last year was another solid year for secondary deal making. with about the same amount of capital raised in the past four years as in the prior nine years going back to 2000. during which $22 billion in commitments were gathered by the strategy. the past year brought in $20 billion in fresh funding for 14 funds pursuing secondary strategies. since the universe of secondary managers is small and many have recently closed on new funds. the past three years have not disappointed on what were high expectations for secondary activity and there is little sign of significant slowing in the pace of investment for 2013. in the history of the secondary strategy.Special Situations > Secondaries Fundraising Secondary fundraising roared back in 2012 after a minor lull in 2010 and 2011. Including 2010. Cogent © 2013 TorreyCove Capital Partners | 35 . following the all-time record year of 2009. by amount. Overall. unchanged from the 2011 total.
it will still tend to be a relatively balanced market. Global PE Barometer © 2013 TorreyCove Capital Partners | 36 .Special Situations > Secondaries 12. Pricing has been highly resilient over the past three years and what looked to be a potential downward move in the latter half of 2011 fizzled as discounts resumed trend levels of approximately 15%.to 18-month commitment outlook > STRONG OVERWEIGHT MODERATE OVERWEIGHT NEUTRAL MODERATE UNDERWEIGHT STRONG UNDERWEIGHT Deal pricing remained essentially unchanged during 2012. so we expect the asset class to put together another robust year in 2013. while the first half showed only a slightly higher bid of 85% of NAV. As mentioned earlier. As is usually the case. it is still not unusual to see limited partner interests in good quality funds going closer to par in today’s market. Some of the more meaningful trends and factors to note regarding secondaries over the next 12 to 18 months are as follows: • Deal flow is expected to remain strong. While this is an average. at about 74% of NAV. The primary factor in supporting prices is the lack of urgency on the part of limited partners. but as noted. Demand and supply in the North American PE market – LP views 100% 80% 60% 40% 20% 0% North American European LPs LPs Buyouts North American European LPs LPs Venture There are not enough highquality GPs The number of GPs is about rightidentifying/accessing the right ones is the challenge Too many GPs chasing too few deals Source: Coller Capital. with reported discounts. Secondaries Outlook As expected. who have been able to pick the timing and terms of sale in large part. per Cogent. coming in at 84% of NAV for buyout funds in the second half of the year. without great selling pressure on the vast majority of transactions. 2012 turned out to be a solid year for secondary strategies in both fundraising and capital deployment terms. the median bid for venture capital funds was meaningfully lower. the key drivers to sustain momentum mostly remain in place.
which was a relatively big year for primary commitments. public pensions have tended to use secondaries to manage and rationalize their portfolios rather than out of distress. (Volcker).0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2013 2014 2015 2013E 2014E $13. However. with several large.3 $8. deleveraging mandates. and therefore have control over exit timing. including: HSH Nordbank’s sale of approximately 47 limited partnership interests to AXA and Lloyds Banking Group’s £1 billion sale of private equity assets to secondary specialist Coller Capital.8 389 325 226 130 74 419 Source: Preqin.0 20. With the dropping-off of the 2005 vintage year.S. TorreyCove Research © 2013 TorreyCove Capital Partners | 37 . Actively Trading Primaries $B Average Trailing 3-7 Year Primaries $B $267 $226 $178 170 165 190 Forecasted Deal Volume 5-10% Turnover $B 30.Special Situations > Secondaries Regulators have provided financial institutions with more than ample time in which to comply with new rules surrounding proprietary holdings. and capital requirements.7 25.0 10.6 $17. Since these two sectors still account for the lion’s share of deal flow. as well as the desire of large institutions to reduce exposure to boom vintage years and reduce the number of managers in their portfolios. financial institution deleveraging provided substantial deal flow for the secondary space in 2012. and the addition of the poor 2009 vintage year. pricing has held up well. Outside the financial industry. • As expected. any marginal reduction in forecast deal flow based on primary commitments is expected to be overwhelmed by dynamics regarding the banking systems in Europe (deleveraging) and the U.0 5. notable transactions booked during the year. the potential amount of secondary deal flow forecasted by trailing 3-7 year primaries has fallen by over 10%. • One factor that has moved against the prospect for secondary deal flow is the reduction in primary commitments within the “sweet spot” for secondary deal flow (see charts below).9 2015E $22.3 $11.0 15.0 $26.
as a non-core asset. the trend in recent Total Deleveraging by Sample Banks 2011 Q3 . European banks have shed over €500 billion in assets over the past year or more. where the immediate pressure on banks has been effectively removed by ECB actions.5 trillion (weak policy scenario). potential seller interest should remain strong in 2013. the trend begun in 2011. large institutional limited partners have been reassessing the structure of their private equity portfolios. • On the investor side of the equation. this is just the beginning of what is necessary. As indicated in the nearby chart. and perhaps intensifying. after taking into account capital measures. the ground is set for an extended run of bank asset sales over the next 12 to 18 months.2013 Q4 $ Trillion 5 4 3 2 1 0 Complete Policies Baseline Policies Weak Policies April 2012 GFSR October 2012 GFSR Source: IMF staff estimates Note: Total deleveraging is obtained by aggregating projected asset reduction of all sample banks. Even if these figures turn out to be off significantly (which they most likely will be). which took the form of too many general partner relationships. In the post-crisis environment. By various estimates. © 2013 TorreyCove Capital Partners | 38 .Special Situations > Secondaries • The deleveraging theme shows no sign of abating. many of them of mediocre quality. Thus. private equity. in spite of the relatively improved position of the financial sector on both sides of the Atlantic. given the regulatory and capital adequacy standards in effect as of October of 2012. For each bank. but according to the IMF. While much of the deleveraging will be accomplished via the sale of real estate-related loan books. the required amount of asset reduction is such that it allows a bank to meet all deleveraging targets. can be expected to play a meaningful role. the IMF estimates that European banks (within its sample) will likely need to deleverage by anywhere from $2. especially in Europe. continuing.8 trillion (baseline scenario) to $4. and many have concluded that there is significant excess that built up in the years leading up to the crash.
with nearly half indicating the intent to cut (compared to about 20% that wish to increase). our expectation was that there would be some downward pressure on pricing. the prognosis for secondary fundraising in 2013 is slightly less robust than was the case at the beginning of 2012. Though there should be a solid year of fundraising.less pressure on European financial institutions. as secondary investors continue to seek synthetic structures for transactions or develop customized cash flow timing frameworks that allow limited partners to achieve their objectives (maintaining some exposure to the LP interests. which has added substantial deal flow to the secondary universe. institutions have been willing to sell and will continue to sell. However. the fact that several large funds have recently traversed the market would indicate somewhat less strength for the coming year. • At the beginning of 2012. Given that most of the factors which would drive larger discounts have either moderated or stayed the same . due to regulatory forbearance and assistance from governments and central banks. The investment side should be quite strong in 2013.Special Situations > Secondaries years to “rationalize” private equity portfolios. © 2013 TorreyCove Capital Partners | 39 . etc. pressure on institutions to sell (Volcker and European deleveraging). it would not be surprising to see the next 12 months exceed the last in terms of capital deployments. and the lack of excessive capital on the supply side (though not a dearth of capital either). For this reason. • Creativity in deal structuring will remain the order of the day. – our expectation is for stable and relatively high pricing throughout 2013 (barring an unexpected shock to the system). As an illustration of this sentiment. and given the amount of capital ready to be deployed and the still-strong drivers of deal flow. etc) while allowing secondary funds to deploy capital at reasonable rates of return. • As noted earlier. due to the large amount of expected deal flow. In effect. given the investor interest in the space. pricing remained stubbornly resilient during 2012. not having to take “too much” of a discount to NAV. North American LPs are by far the most aggressive in this respect. improving private equity portfolios of large institutional investors. Coller Capital’s Global PE Barometer for Winter of 2012 indicated that the interest on the part of LPs to cut the number of active GP relationships within the next two years has increased across the board (since 2006). but are under little pressure to sell. there is a pretty high floor under pricing.
the actions of the ECB appear to have doused the fire for now. we anticipate another solid year in secondary transaction activity. a sustained flare-up with respect to either of these would be it. the wild card for this entire strategy remains the European debt and currency crises. and given that fundraising in the space has been strong for the past few years. If anything is likely to trigger massive selling pressure. Other factors include the expectation that there is unlikely to be an event or action that will catalyze downward pressure on pricing. indicating a meaningful increase in supply of capital on a relative basis. Nevertheless. and the moderate decrease in the amount of trailing primary limited partner interests in the “sweet spot” of the secondary strategy.Special Situations > Secondaries • Of course. However. The primary driver of European deleveraging at this point is the pressure by European regulators on banks to improve capital ratios. and the probability of such blow-ups has been reduced to a much lower level than just about one year ago. We are moving our rating for secondaries strategies from “Moderate Overweight” to “Neutral. © 2013 TorreyCove Capital Partners | 40 . with a record year in 2012. We simply believe that the opportunity to earn an outsized return has reduced on the margin compared to prior years as the asset class has become more efficient. in large part due to the defusing of the immediate European debt and currency crises.” This is based on the fact that selling pressure has been reduced significantly.
Fundraising Despite a downbeat fourth quarter in 2012. it wasn’t all Facebook – even without that deal. However. but significantly reduced. and would put it in the league with 2010 and 2011. The primary departure was with respect to exit activity.Venture Capital In terms of fundraising and investment activity. with the Facebook IPO propelling 2012 to a status as one of the best periods for exit activity in many years. the two strongest years (ex-Facebook) for post-crisis IPO activity (by amount). This is the third straight year with an increase. venture firms. Just over $20 billion in fresh commitments were raised by U. 2012 was another steady year for the venture capital asset class. an increase of approximately 10% from the fullyear 2011 totals.S. as the industry continues to U. Our expectation for 2013 is for a reasonable. exit environment and another stable year for investment and fundraising. both of which can be characterized as at or near equilibrium levels at present. Venture Capital Fundraising Activity $ Billion $40 $30 $20 $10 $0 2005 2006 2007 2008 2009 2010 © 2011 2012 Source: Thomson Reuters & National Venture Capital Association 2013 TorreyCove Capital Partners | 41 .S. the entire year of 2012 turned out to be fairly decent for venture fundraising. during which just over $3 billion in new commitments were garnered (nearly a 50% decrease from the 2011 fourth quarter). the IPO performance for 2012 was respectable.
followed in distant second place by life sciences. which was the best year for investment since the crisis hit.000 4.stage segments over the year. with nearly one-third of dollars flowing into each of the seed/early-.000 2. The number of funds raised during 2012 was essentially unchanged from 2011 and the percentage of existing funds within the mix (opposed to first-time funds) held relatively steady at close to 70%. $27 billion was invested in 2012. though the year ended up slightly short of 2011.000 1.3 billion). VC Investment Activity AMOUNT INVESTED $ Billion NUMBER OF DEALS $40 $35 $30 $25 $20 $15 $10 $5 $0 2005 2006 2007 2008 2009 2010 2011 © 5. expansion-. The most attractive target sector for venture investment during 2012 was software.S. and regain the $30 billion per annum fundraising totals that were common for much of the decade before the crash. off approximately 10% from 2011 in terms of value. By stage of investment.1 billion) for the year.Venture Capital climb out of the hole it fell into (along with most others) in 2009. U. which took in about half that amount ($4. which garnered close to 31% of all investments ($8. and later. Investment Activity Venture investors deployed capital at a steady pace in 2012. the venture sector showed a good deal of balance.000 0 2012 2013 TorreyCove Capital Partners | 42 Source: National Venture Capital Association .000 3. In total. but only about 6% by number of deals.
This is somewhat off last year’s pace of 488 deals generating $24 billion in reported proceeds (169 companies) – by about 11% in both cases. even without the impact of Facebook.S. Based IPOs $ Billion 100 Venture-backed Buyout-backed Number of U. with disclosed deal values totaling approximately $5 billion.-Based M&A $ Billion 600 500 Venture-backed Buyout-backed 75 400 50 300 200 25 100 0 2005 2006 2007 2008 2009 2010 2011 2012 Source: Thomson Reuters & National Venture Capital Association 0 2005 2006 2007 2008 2009 2010 2011 2012 Source: Thomson Reuters & National Venture Capital Association © 2013 TorreyCove Capital Partners | 43 .S. exit environment that has recovered from the post-crisis pit of 2009. However. So while Facebook provided a massive uplift to the exit performance of the venture space in 2012. Extending the momentum from 2011.Venture Capital Exits Clearly it was a solid year for venture capital exit activity. if unexceptional. 2012 turned out to be a fair year for venture-backed companies going public: 48 other companies were listed. the ex-Facebook numbers provide a picture of a steady.would ensure that. the M&A exit route for venture-backed companies proved to be resilient in 2012. Number of U. as 435 companies were sold in trade sales with a total disclosed value (120 companies) of $21 billion. The year demonstrates that the markets are open to the acquisition of good quality companies. The Facebook IPO alone – which gathered a record $16 billion in May of 2012 . shy of the 2010 totals but well ahead of the poor showings from 2008 and 2009. even if euphoria is not to be found.
since there is only one Facebook. and we expect a steady year in the $20 billion to $25 billion range. 2013 is likely to see an IPO market that continues to be open for good quality companies and a steady M&A environment. investment levels.to 18-month commitment outlook > STRONG OVERWEIGHT MODERATE OVERWEIGHT NEUTRAL MODERATE UNDERWEIGHT STRONG UNDERWEIGHT Outlook The venture capital arena has not been particularly dynamic over the past few years. which has recently exhibited a “barbell” pattern of investment – early-stage and later-stage investment predominating. 2012 was a balanced and steady year. © 2013 TorreyCove Capital Partners | 44 . • In light of an improving economy and 2012s decent performance in terms of exits. with somewhere around $25 billion deployed. Some of the key factors to consider for the asset class in 2013 are as follows: • The prospects for fundraising are not expected to change appreciably from 2012. This bodes well for investors that are exposed to funds that have meaningful expansion-stage capital to invest. regarding fresh capital entering the industry. but a broad-based. the venture capital sector appears quite well-balanced. indicating an increased risk of a “crunch” in the middle investment stage. with relatively less mid-/expansion-stage capital deployed. the IPO exit numbers are almost certain to decline meaningfully. if moderate. • One area that might be potentially out of balance is the investment stage. supply of exit candidates should maintain some of the post-crisis momentum that began in 2010. For one reason or another – perhaps due to its less-than-perfect execution – that IPO didn’t demonstrate a discernible “coattail effect” or generate significant momentum on the investment or exit sides for the venture capital markets. • The visibility on changes in investment flows likewise indicates another year similar to the past year. and even exits.Venture Capital 12. and indications are that 2013 is likely to fall into the same mold. Nevertheless. with the notable exception of the highly-anticipated Facebook IPO. • Overall. Of course. with no large overhangs and a sustainable level of activity.
established funds. but there should always be some churn in the early-stage area. Our tactical rating for venture capital strategies remains at “Neutral. respectively).Venture Capital • The trend of industry consolidation that began several years ago will continue apace. while many smaller firms (or those without a long track record of realizations). have had comparatively easy fundraises in recent years. and focus has now shifted to enterprise-oriented IT themes. • The IT sector is expected to consolidate its current leadership of investment flows. have not been able to raise funds at all. increasing relative fund flows to better quality managers. Large. social media investments appear to have passed their peak. as the life sciences and clean technology sectors deal with headwinds (regulatory/reimbursement and performance. especially those in the later-stage and growth areas. The institutionalization of the venture space will invariably lead to far fewer managers 10 years from now.” Most of the same factors on which our “Neutral” rating last year were based are still in place: relative equilibrium of the industry in terms of capital flows. On a more specific basis. and potential access to such managers by institutional investors that have formerly been restricted. © 2013 TorreyCove Capital Partners | 45 . What has changed is that leadership will probably shift further to IT at the expense of life sciences and that the exit outlook has somewhat better visibility.
both countries made some progress on these twin goals. India has taken the edge off of inflation. At the beginning of 2013. In terms of GDP growth. but China appears to have come out the other side in better shape. but it still hovers at or above the central bank target range. the intensity of their ardour for the region appears to have cooled somewhat over the past year. both China and India were looking to manage moderating GDP growth that primarily stemmed from the troubles of their trading partners in the developed world. After several years of blistering macroeconomic growth. as growth in its emerging markets still outperforms developed markets. as indicated by the following graph showing investor sentiment LPs Now Less Attracted by Asia-Pacific Buyouts and by Venture Capital European Venture Asia-Pacific Venture North American Venture Asia-Pacific Buyouts Europen Buyouts North American Buyout Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 2009 2005 2006 2007 2008 2010 2011 2012 Source: Preqin Asia-Pacific Fundraising by Quarter $ Billion 30 25 20 15 10 5 0 Aggregate Capital Raised Winter 2008-09 Winter 2012-13 0 20 40 60 80 Source: Coller Capital Global Private Equity Barometer © 2013 TorreyCove Capital Partners | 46 . thereby providing a counter to more aggressive interventionist policy by the bank to stimulate the economy.Select Emerging Economies > Asia Coming into 2012. as well as strengthening inflation. with a restrained inflation rate and growth momentum by the end of the year. at least in part due to further government stimulus. the watchwords for Asia’s largest economies were: slower growth and uncertainty. Fundraising Asia-focused funds (primarily those investing in Greater China) continue to be sought after by institutional investors the world over. India looks to be about a year behind China for a full recovery. However. with next year’s growth expected to be at the moderate (by current emerging market standards) level of 5% to 6%.
Funds Raising 900 700 Aggregate Target 500 300 100 -100 North America Europe Asia/ROW Source: Preqin Source: Preqin © 2013 TorreyCove Capital Partners | 47 . with Asia (primarily Greater China and India) continuing to account for the strong majority of investor interest in new capital commitments. For 2011. Asia lost some ground on a relative basis. off nearly 20% from the prior year (just over $56 billion). fundraising for the Asia region came in at just over $46 billion. As European fundraising rebounded meaningfully from 2011 levels and the North American buyout sector reasserted itself on the fundraising front in 2012. coming in about 10% short of the European total for the period. For 2012. Furthermore. Further. Fund Raised 80 70 60 50 40 30 20 10 0 North America Europe Asia/ROW Aggrgate Commitments Composition of Funds in Market by Primary Geographic Focus $ Billion No. Asia/ROW fundraising (predominantly China) accounted for about 21% of fresh private equity capital raised. Fundraising by Primary Geographic Focus Q3 2012 $ Billion No. and there was even talk of a “hard” landing for the country. and still well off the peaks seen in 2007 and 2008. as the growth prospects for China. as the region probably was the recipient of some less than rational euphoria during the pre-crisis years and 2011 – 2012 probably represents a more sustainable level of funding for its still-nascent private equity industry.Select Emerging Economies > Asia regarding the region. exit markets have come back down to earth and so realizations by private equity investors have slowed in tandem. Asia beat out Europe in garnering new commitments by close to 20% in 2011. In terms of the regional breakdown within total Asian fundraising. with over 70% of commitments for 2012. but relinquished that lead in 2012. the main driver of the region. This is not entirely surprising. This is not altogether a bad turn of events. compared to approximately 26% for the prior year. there has been little change. had slowed meaningfully in 2012.
Select Emerging Economies > Asia
With respect to capital deployment by private equity investors in Asia, 2012 was a somewhat disappointing year. At $60 billion for the year (according to ACVJ), 2012 investment came in right at 2008 levels, and off by over 10% in comparison to each of 2010 and 2011, both reasonably solid post-crisis years. However, a look underneath the aggregate Asia figure reveals some nuance. For instance, investment in Mainland China, while down by around 25% from 2011 levels and about 15% from 2010 levels, still outperformed all years prior to 2010 by a wide margin. This would indicate that, while the various issues noted earlier that are weighing on investor sentiment towards China are having an impact, the overall positive trend for private equity investment in the region remains on track. Unfortunately, the same cannot be said for the other emerging power in the region: India. After clawing its way back to a respectable level of private equity investment in 2011, the region saw flows decline by approximately one-third in 2012. What’s worse is that this level is just barely above the 2009 trough and about 60% down from India’s peak investment year of 2007. We expect 2013 private equity investment flows to improve in Greater China, as the macroeconomic and political environments in that region offer a higher level of certainty than existed one year ago. Further, with public market valuations at farreduced levels, value investors may find reason to deploy capital aggressively. For India, the picture is more problematic, as the country seems to be suffering more from a loss of investor confidence than simply macroeconomic concerns. Our expectation for India is a relatively flat to slightly higher year for capital deployment.
In general, global IPO markets were relatively moribund for most of 2012, with the relative exception being in the U.S., where volume increased year-over-year. Chinese exchanges had some of their worst years since the beginning of the crisis in 2012; in fact, they gave up their leadership status in the post-crisis era to the U.S. this year. In total, Chinese IPOs generated over $21 billion in 2012, a marked decline of over half since 2011. Both the Hong Kong and Mainland exchanges logged very poor years in IPO performance, with all three off about two-thirds or more in terms of IPOs in comparison to 2011. Of course, the primary culprits behind this slump are the
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Select Emerging Economies > Asia
slowdown in the larger Chinese economy and the attendant fall in share prices of publicly-traded companies, coupled with some concerns over a menu of issues currently facing the country: potential property bubbles, the sustainability of capital spending, accounting scandals, and the recent leadership change. With some of these issues resolved or otherwise addressed and China’s economy still growing above trend (in comparison to the rest of the world), there may be a case for a more optimistic outlook on exit markets in 2013. On that front, the $3 billion fourth quarter IPO of People’s Insurance Company on the Hong Kong exchange may be an omen of things to come. In fact, the Hong Kong exchange generated about 50% of its total IPO amount for 2012 from the fourth quarter alone, indicating signs of potential life for 2013. The Mainland exchanges, however, saw no such rebound in the fourth quarter, meaning a robust, broad-based IPO resurgence in 2013 is still an open question. The M&A markets for Asia-based private equity fared similarly to the IPO markets in terms of value (though the volumes held up better), registering a material decline from what was a relatively strong year in 2011 (the best year for private equity M&A since the crisis, in fact). For 2012, private equity M&A flows shifted down to around 225 deals and just over $30 billion in value from over 250 deals and around $50 billion in value for the prior year, a relatively steep decline of over 60% year-over-year, by value. On the positive side, both the value and volume of private equity M&A in 2012 came in higher, if just barely, than for any of the years since 2007, except 2011.
Priced IPOs – China: Mainland Exchanges (Shanghai & Shenzhen) $ Billion
AMOUNT OF DEAL FLOW IPO COUNT
80 60 40 20
400 300 200 100
Source: Bloomberg; China Daily
2007 2008 2009 2010 2011
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Select Emerging Economies > Asia
12- to 18-month commitment outlook >
Developing markets, the darlings of the investment world for much of the post-crisis era, lost a bit of their luster in late-2011 and 2012. As anticipated, growth in China slowed appreciably, and there was some concern over what the likely depth of the decline in GDP would be for 2012. It appears that the rumors of a possible “hard landing” were exaggerated, as the region’s economy expanded by an estimated 7.8% for the full year, including a hot fourth quarter. So far, estimates for 2013 are signaling GDP growth of over 8% for the year. The inflation rate, which was of such concern in 2011 (trending at over 6%) and remained an issue at the beginning of 2012 (trending over 4%), is well within control at close to a 2.5% annual pace of increase as of December 2012, indicating the government’s concerted efforts to stymie price increases – along with the cooling economy – have been largely successful. Once again, the scene in India looks less rosy. The region’s GDP growth rate, which has disappointed since 2011, turned in a mediocre performance in the third quarter of 2013 – a 0.6% increase from second to third quarters – indicating that the economy appears to be running low on steam. After a decent showing of nearly 7% in 2011, India’s 2012 GDP growth is expected to come in around 5.5% on an annualized basis. Estimates for 2013 are in the same range. Meanwhile, rupee inflation remains stubborn, with annualized rates of over 7% for nearly all measured periods in 2012, albeit down from the troubling levels of 9% to 10% that were regular occurrences throughout 2011. With the economy stalled and the Reserve Bank of India on an easing trend, the wild card of inflation remains a major concern and one of many potential headwinds for the Indian economy. Overall, emerging economies will be more of a mixed bag in terms of performance in 2013, with China looking to maintain its status as the leader, based on its relatively low inflation and continuing macroeconomic growth trend, which appears to have stabilized at the end of 2012. India will be fighting inflationary fears while attempting to spur its economy to higher growth, so the outlook there is more opaque.
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• RMB-denominated funds. the source of renewed vigor in the manufacturing sector looks to be primarily domestic demand. many of these funds may be forced into less than ideal exits sometime in the next two years. and are therefore more reliant on strong capital markets to achieve relatively rapid exits.-dollar-denominated vehicles in the fundraising races over the past two years. which had been below 50 (indicating declining activity) for much of 2012. as export growth has remained relatively flat or negative in 2012 and going into 2013. • The all-important manufacturing sector in China appeared to awaken toward the end of 2012. there is nearly $80 billion committed to such funds. The slump in China’s exit markets throughout 2012 is likely to bring pressure on many of these funds. the consensus growth rate of 8% or more for next year looks reasonable. the measure has been on an uptrend for five consecutive months and has been in positive territory for three. The January 2013 HSBC/Markit PMI reading. which are required to invest all of their capital in companies operating in the Chinese domestic markets (possible loosening of this requirement has been discussed). especially for those raised in 2010. as they are not able to effectively exit while markets are down and while time is running out on their formal lifespans. the most positive reading in two years going back to January of 2011. came in at 51. By some estimates. Absent a regulatory intervention or a rapidly-strengthening IPO market.S.Select Emerging Economies > Asia China • After a solid fourth quarter performance. the Chinese economy appears to have gained some momentum after a year that was somewhat down by its more recent standards.9. © 2013 TorreyCove Capital Partners | 51 . Further. RMB funds have much shorter lifespans than their nonRMB counterparts. Interestingly. which have been the rage in China since their introduction in 2010. and even bested the latter in some periods. achieved parity with U. While achieving regular 10% GDP growth year-after-year will soon be out of reach. which bodes well for economic growth in 2013.
with a focus on traditional infrastructure (roads. subways) as well as clean energy projects and heavy industrial expansions.Select Emerging Economies > Asia • The valuation of public companies on the Chinese exchanges is having a variety of effects within the China-focused investment world. soaring to 50x or more during the 2007 peak. 2012 saw relatively flat domestic demand growth. the most recent stimulus program weighs in roughly one-quarter the size of the massive 2008-2009 stimulus rolled out by the government to stave off a recession. more or less on a par with the valuations of their developed world counterparts. airports. as lower public valuations may have the effect of moderating price expectations relating to private Chinese companies and the competition from high net worth investors and RMB funds should be less intense. which has in turn made fundraising a much more difficult prospect. This has had a negative effect on RMB-denominated funds. © 2013 TorreyCove Capital Partners | 52 . The estimated value of the programs is close to $160 billion. Price/earnings ratios. All of the above-mentioned factors should play well to more traditional private equity investors in the coming year. rail. have fallen dramatically over the intervening years. in spite of pronouncements by the government that it wishes to encourage the economy into a more balanced status whereby domestic demand accounts for a larger percentage of growth. which have seen their primary exit route obliterated until a rebound in the public markets takes hold. While there is some indication that domestic demand has grown in the past couple of years. and the impact of these projects appears to have begun to show up in the fourth quarter 2012 GDP growth figures. For perspective. • The Chinese economy continues to rely heavily on fixed capital investment flows. Many high net worth investors in China – expecting quick turnarounds on their investments – have now begun to flee pre-IPO strategies. and are now at levels between 10x and 20x. • As a response to the slowdown in the economy during the first half of 2012. most likely as a result of the slowing GDP trend that year and relative weakness in exports and manufacturing activity. the National Development and Reform Commission announced a plethora of approved projects that would be funded by various government entities.
significantly more attractive company valuations in the public markets (which is hoped to extend to private markets). It remains uncertain whether all of these projects will actually see the light of day. controlled inflation. Both of these would be clearly positive changes. © 2013 TorreyCove Capital Partners | 53 . the China Securities and Regulatory Commission (“CSRC”) recently announced its intention to perform an extensive review of all companies currently in queue for an IPO listing – some 880 firms. Market observers estimate that the CSRC wishes to cull the list of IPO candidates by approximately 300.8 trillion. These entities have apparently green-lighted various projects totaling over $1. and that private equity-backed companies could be a major target group. • With some freedom of operation due to more restrained inflationary pressure. especially the development of a robust trade and secondary sale market – currently in a less than ideal state – as an alternative exit route for private equity-backed companies. and the resulting weakening of confidence by investors. The effect of this policy is likely to manifest in two primary ways: a more manageable. universe of IPO candidates and a more robust secondary and trade sale environment for private companies in China. the People’s Bank of China is likely to pursue a more expansionary monetary policy in 2013. • In response to a fraudulent IPO listing in 2012. and the medium-term growth prospects for the country. Companies are being encouraged to review themselves and voluntarily withdraw from the IPO track if their performance has not been as strong as originally estimated or if there are other factors that argue against an IPO. Our tactical rating for China will remain at “Moderate Overweight. The bank cut both reserve requirements and the benchmark rate more than once during 2012 as signs of weakening economic performance became apparent. in order to provide momentum for economic and employment growth. but the impact will be spread over the next three to five years in any case.Select Emerging Economies > Asia • It appears that the real stimulative action going into 2013 and beyond will come from the local government coffers. the resolution of the leadership change process. and perhaps reliable.” Key factors in this rating include: a rebounding macroeconomic growth picture.
75%) and a minor cut in its required reserve ratio.0% (many revised downward after a poor second half GDP growth showing) and do nothing to improve confidence in the ability of the Indian economy to resume the strong growth that was the norm just a few years ago. © 2013 TorreyCove Capital Partners | 54 . GDP growth of between 5. exports. the inflation rate remains a concern. This comes on the heels of a strong 2011 and is implicated in both the overall cooling of the economy and the worsening trade balance situation currently affecting India. were off by approximately 5. the Indian macroeconomic picture declined significantly in 2012 and there is not a great deal of momentum going into 2013. In spite of some cooling. • As anticipated last year. With inflation expected to run only moderately under the repurchase rate and the RBI now focused more intently on jumpstarting the economy.5% and off nearly 2% for the month of December (compared to December 2011). Currently. most estimates for 2013 growth are coming in at under 6. Further.5% and 6% for the past year will represent one of the worst periods for the economy in the past ten years. in addition to a slow but steady recovery by the developed world. as the RBI recently announced loosening moves – including a reduction in its repurchase rate (from 8% to 7. • Also as anticipated. For the April through December 2012 time frame. As a result of some tightening by the central bank and a slower economy. It is hoped that such measures. also expanding the subsidy to the important engineering sector. higher future inflation is a real risk in the next two to three years.Select Emerging Economies > Asia India • As noted earlier. the inflation forecast has now fallen to just under 7% and is expected by the central bank to remain range-bound near this level for the next year or so. the RBI was able to restrain burgeoning inflation (9% or more in 2011) – to a point. in dollar terms. a recovery in excess of 6% growth is now not expected until 2014. Indian exports – a very important segment of the overall economy for the region – fell meaningfully for much of 2012. In December of 2012. will eventually reinvigorate Indian export sector performance. the government announced the extension of 2% export loan subsidies to Indian industry.
value plays will continue to be enticing to foreign and domestic investors. there is certainly some wind at the back of the sector.Select Emerging Economies > Asia • One very positive development for India came from the manufacturing sector. but may see some improvement in 2013 due to improved (or stable) conditions with respect to India’s most important trading partners. Overall. which appears to have avoided a potential slump that looked imminent as of the end of 2011. Export performance was disappointing in 2012. With the HSBC India Manufacturing PMI indicator reading 54. mostly in that it may serve as a barrier to more aggressive action by the RBI to stimulate the economy. Public market valuations and manufacturing sector vigor both serve as positive drivers going into 2013. • After a worse-than-expected year in terms of growth. While not out of control.7 in November). With a price/earnings ratio hovering at or below its current level of 18x (Sensex) for much of 2012. PMI readings have been in positive (growth) territory for the past four years.7 in December of 2012 (after a relatively solid 53. with a gain of approximately 18% (January 2012 to January 2013) for the Sensex index (Bombay Stock Exchange). © 2013 TorreyCove Capital Partners | 55 . Increasing strength in the manufacturing sector can be expected to provide one of the few positive boosts to the Indian economy in 2013 and beyond. inflation remains on the radar as a potential problem. • The equity markets in India turned in a better-than-expected performance for 2012. India appears set for a repeat of subpar economic growth for 2013.
and persistent structural problems that do not seem close to being addressed. a sluggish export sector. if left largely unresolved. perhaps toward the end of the year and going into 2014. or deal with the notoriously inefficient bureaucracy that has hampered Indian growth for years. Our rating for India will shift to “Neutral” from “Moderate Overweight” due to the lack of strong momentum for economic growth in 2013. inflation remaining well over the government’s target range. valuations in the Indian public markets remain at relatively attractive levels. These would include a general lack of confidence in the government’s ability to manage the economy (and itself). and longer-term. will continue to maintain a ceiling on the level of private equity investment the country is likely to garner. On the brighter side. issues. these structural issues. and should prove an enticement to private equity investors (if the valuations are translated to private companies) once the economy shows some more signs of strength. a drop which looked to be out of proportion to the dip in GDP growth or other macroeconomic indicator deterioration. © 2013 TorreyCove Capital Partners | 56 . drive needed reforms. Private equity investment in India (as reported by ACVJ) flagged by over 25% compared to the prior year’s level. it looks most likely that private equity investors are shying away from the region due to larger. While private equity investment is likely to pick up in 2013.Select Emerging Economies > Asia • 2012 saw a major decline in private equity investment in India. and was the worst showing since 2009. While the magnitude of the Indian slowdown was larger than China’s.
and hence on the larger economy. Brazil has had a tough run of late. Further.5% in December) to a low of just under 5% midway through 2012. but the year is not expected to be a return to the rapid growth seen in 2010 and earlier years. when the region’s growth was in league with that of China. the rate has bounced back up as the central bank has been forced to ease in the face of sluggish economic growth. with a slightly more robust performance in 2014. with a persistent threat of inflationary pressures ever in the background. with GDP growth surprisingly on the downside and inflation that appears in control but not at comfortable levels. After a relatively lackluster year in 2011. All of this after a stunning year in 2010 (over 7%). inflation is likely to be a confidence-eroding factor for the Brazilian economy for much of the next year or two. At a current rate of near 6%. with GDP growth under 3%. with the USD/Real exchange rate moving from 1. Given the policy stance of the central bank and the weakening of the exchange rate. dollar and other major currencies.Select Emerging Economies > Brazil Brazil had a more difficult year than expected in 2012. One factor from last year that was weighing heavily on the manufacturing sector. While the Bank of Brazil’s tightening actions managed to bring the rate down from its highs of over 7% in 2011 (6. the ground for a recovery in 2013 looks to be in place. the consensus estimate for growth in 2013 is just over 3%. inflation has proven resilient. © 2013 TorreyCove Capital Partners | 57 .S. The most likely path for Brazil calls for a slow improvement over the next two years. 2012 could not manage to break out from a GDP growth rate of 1%.65 real near the beginning of 2012 to over 2. After downward revisions. was the strength of the Brazilian real in relation to the U. Overview In terms of economic growth.0 real by the end of the year. This currency weakening should provide some needed help to the export and manufacturing sectors over time. There was a major weakening of the real in 2012 as a result of lower economic growth and the resumption of a more accommodative monetary policy. and with estimates for 2013 of a rate in the mid5% range.
historical fundraising for Brazil tends to come in at less than $2 billion in most years. The problem is that positive talk did not translate into capital commitments for 2012. and the supply of capital at this point is most likely in rough balance with quality deal flow (or perhaps oversupplied). which weakened significantly in 2012. as there are good reasons for the decline. it is important not to read too much into this. After a strong year on the fundraising trail in 2011. Of course. the bottom more or less fell out in 2012. where 17 funds closed on about $10 billion in fresh capital.Select Emerging Economies > Brazil Fundraising Private equity investors continued to talk Brazil up during 2012 and interest remains high in this large emerging market. Fundraising $ Billion AGGREGATE FUNDRAISING NUMBER OF FUNDS Brazil Current Account Balance $ Billion 20 10 0 -10 -20 -30 -40 -50 -60 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20 16 12 8 4 0 2006 2007 2008 2009 2010 2011 2012 Source: Preqin Source: World Bank & Trading Economics © 2013 TorreyCove Capital Partners | 58 . when 7 funds were able to gather only $1. However. including the fact that a few large funds moved through the market in the one or two years leading up to 2012. probably had something to do with the dip in fundraising as well. the overall economy of the region.4 billion in new commitments.
but it also managed to choke off foreign investment. when over 60 firms listed on the Bovespa and cleared close to $25 billion in funding. a dose of skepticism is in order. with over 600 deals being completed in the first three quarters of 2012. © 2013 TorreyCove Capital Partners | 59 . a great deal of hype at the beginning of 2012 – when over 40 companies were anticipated to go public during the year – gave way to something like despair. However. This appears to have worked. given that the Brazilian economy is still not back to strong growth and many of the structural problems inhibiting IPO flow remain in place. In order to cool down hot offshore investment flows that were causing the real to appreciate strongly (thereby weakening exports and manufacturing). there are predictions of a strong rebound in the IPO markets for 2013. The recently announced IPO of communications technology company Linx (over $200 million) may be a harbinger of a better market in 2013. have also been implicated in the lack of IPO activity for 2012. a steep decline in comparison to the prior two years. indicating close to a 6% increase over 2011 deals. M&A had a solid year. each of which had about three times the number of listings and more than double the total proceeds. as well as investor perception that many Brazilian IPOs are over priced considering their risk. as the market all but collapsed during the year. and several large firms are planning to go public (the insurance division of Banco do Brasil and a division of Gol Linhas Aereas). as the real has depreciated significantly. either. the government has signaled a shift to a more investor-friendly posture in 2013. Currency depreciation. Government policy has not helped. Further. but near the top of the list is the poor performance of the Brazilian economy. which is the life blood of the Brazilian IPO market. In a sign of continued maturation on the part of Brazilian markets. The reasons for this poor performance vary. and the active government efforts to manage it. the government instituted taxes on capital flows and used regulatory measures to attempt to stem the tide.Select Emerging Economies > Brazil Exits For the Brazilian IPO market. gathering less than $2 billion in total proceeds. And none of these years come close to the peak of 2007. Only three companies were able to float shares in 2012. Once again.
At an annual rate of close to 6%.5 6. as it had just completed a tightening trend throughout 2011 in order to combat inflation. relative financial stability in comparison with prior periods.5 © 2013 TorreyCove Capital Partners | 60 . Our outlook for 2013 and into 2014 notes the following key elements: • As it did in 2012. a young and upwardly mobile work force. a slow recovery. In fact. certainly with respect to GDP growth. the Bank of Brazil in the coming year will have to navigate a narrow channel between fostering economic growth and keeping a lid on inflation.5 5.5 18000 16000 14000 10/11 12/11 10/12 12/12 2/11 4/11 6/11 8/11 2/12 4/12 6/12 8/12 Jan/11 Jan/12 Jan/12 Jul/12 Jan/13 4.to 18-month commitment outlook > STRONG OVERWEIGHT MODERATE OVERWEIGHT NEUTRAL MODERATE UNDERWEIGHT STRONG UNDERWEIGHT Outlook In a year where other major emerging market growth stories like those of China and India lost some of their upward trajectories.Select Emerging Economies > Brazil 12. currency fluctuation. Of course. and inflation. During 2012. in many ways the region performed even worse than its emerging market brethren. seems to be the most likely course for 2013. the drivers of long-term growth and wealth creation remain in place: abundant natural resources that can be developed. Brazil Inflation Rate Brazil Exports by month (USD million) 28000 26000 24000 22000 20000 7. beset by potential problems associated with foreign trade volatility. With respect to the nearer-term prospects for the country. Brazil was no exception. the bank had significant room to ease. Brazil’s current inflation sits near the top end of the central bank’s stated comfort zone. and a growing middle class.
The combination of currency depreciation and improving economic growth in much of the world. Given the importance of exports to the Brazilian economy. Brazil is in a better position at the beginning of 2013 to deliver economic growth than it was at the beginning of 2012. • Brazil’s critical export sector weakened during 2012. offer some hope to a strengthening of export performance next year. The government has taken measures to boost export growth. but should come in better than 2012’s showing. a 20% drop in exports to Argentina was a major factor. • Macroeconomic growth for the country is expected to be moderate – around 3.25% and inflation apparently stable but sticky. While overall slackened world demand was implicated. The Bank of Brazil may have less room to maneuver in terms of simulative rate cuts in the coming year. especially on the commodity export front. particularly China. © 2013 TorreyCove Capital Partners | 61 . further monetary easing is not a given for 2013.5% for 2013. as the central bank has indicated its willingness to embark upon material rate increases once the inflation rate breaks out of its target range. or an unexpected shock from the EU. dipping 5.3% on a year over year basis. Major downside risks involve a renewed slump in growth in China. The apparent rebound of China to stronger growth should provide some positive momentum. The depreciation of the real over the past year should also provide some tailwind to export growth for 2013. however. a more general slowdown in world growth. • Inflation should remain stable and hover around 6% in 2013.Select Emerging Economies > Brazil • With a current Selic rate of 7. Overall. most importantly in terms of weakening the real. • Fundraising by private equity firms is not expected to come close to 2011 levels. so a relatively stable trend for interest rates is expected. continuing marginal improvement on the economic growth front for much of the developed world will be critical to the region’s growth prospects this year.
which would serve to spur even greater deployment of private equity capital in the region. and keeping a wary eye on inflation. including the depreciation of the real. The continuing IPO doldrums may eventually have some impact on the pricing of private equity deals in Brazil. The cooling of public market valuations continues to be a positive factor in terms of generating foreign investor interest. generating GDP growth momentum. this will become even more urgent priority for government and business interests. and improving economic prospects for many of its important trading partners. • On a long-term basis. who will wish to more effectively co-opt private capital into modernizing projects. Several factors have moved in the country’s favor over the past year. It has become ever more clear over the past few years that the inadequacy of transport in Brazil has created supply bottlenecks that have seriously impacted its actual and prospective growth rates. stabilization of inflation.Select Emerging Economies > Brazil • Private equity investors should continue to invest capital at a fairly regular pace in 2013. we continue to see infrastructure investments as quite attractive to the private equity investor. Eventually. Our tactical rating for Brazil remains at “Neutral. The relative strength of the M&A exit route should serve to boost investor confidence that realizations can be generated even absent a robust IPO market. This is based primarily on the relative deficiency of the country in terms of all types of infrastructure.” with a cautiously optimistic outlook for a more bullish rating by the end of next year. The major challenges for Brazil in 2013 will be related to boosting export performance. © 2013 TorreyCove Capital Partners | 62 . but especially in regard to the transportation sector. as interest in the region remains high.
and innovative investment products.TorreyCove Capital Partners is a global alternative investments specialist. MA 01923 NEW YORK 140 Broadway 46th Floor New York. we create value through a combination of private equity market intelligence. NY 10005 (Unstaffed satellite office) . Our core mission is to partner with our clients to create world class customized investment solutions that appropriately mitigate risk and enhance long term performance potential. As a clientoriented firm. CA 92121 MASSACHUSETTS 222 Rosewood Drive 3rd Floor Danvers. please visit: www. objective advice. To find out more about our firm.torreycove.com. insightful investment guidance and selection. CALIFORNIA 4365 Executive Drive Suite 900 San Diego.
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