Reading the PE tea leaves

Kevin Dowd Staff Writer

Phil Colaco knows his way around the middle market. He's worked as an investment banker in the space for the past two decades, including the past six years as CEO of Deloitte's U.S. investment bank—last year, his team advised on about 700 transactions. So as questions swirl about what volatile stocks, rising interest rates and a shifting economic outlook could mean for private equity firms and other strategic acquirers, his brain seemed like a good one to pick. The market looks different today than it did at the start of the year. Gone is the era of dirt-cheap debt and surging stock prices. Rising rates, rocky equity markets, war in Ukraine and inflation have combined to create a dealmaking slowdown. But Colaco suggests a dose of perspective: What things are slowing down from, after all, is the most breakneck year in the history of private equity. On a longer timeline, current conditions don't look so unfriendly. "Is it worse than it was four months ago? Yes. Is it bad in any sort of historical context? No," Colaco says. "The big change is there has been a little more bifurcation. If you're a B+ to an A+ company, you're still getting very high multiples, great valuations, lots of bidders. If you're a B- or below business, I do think valuations have come down."

Phil Colaco Courtesy of Deloitte

For private equity firms, the most significant shift may be higher interest rates—and the likely prospect of further increases in the months to come. When rates were near zero, firms were able to rely on piles of essentially free debt to finance their buyouts. Now that debt is getting more expensive. "Just doing simple math, either the buyer is going to have to take a lower return, or they're going to pay less," Colaco says. "That's where the rubber really hits the road." Before the global financial crisis, major Wall Street banks were the primary lenders that fueled the buyout industry. But their activities were curtailed by new regulations in the wake of the crash, and in the past decade, a new class of private debt lenders has filled the void—business development corporations, hedge funds and other investors willing to embrace a little more risk in exchange for potentially higher returns. That risk was minimal in recent years, when times were good. Now, it might be getting a bit more significant. When the economy took a turn for the worse in 2008, it was big banks that felt the crunch first. If it happens again in 2022, Colaco says these sorts of private lenders will be on the front line instead. Another slice of the private market that could be in line for a shakeup is ESG. Using environmental, social and governance principles as a guiding light for investing has grown more popular in recent years. But for private equity, it's become more popular largely because that's what LPs are asking for—not necessarily because the firms themselves think it's the best path to profits. There are different schools of thought. Much of recent Wall Street history has been driven by the idea of maximizing shareholder value—essentially, that the point of a company is to make as much money as possible for shareholders. More recently, we've seen a rise in maximizing stakeholder value—essentially, that the point of a company is to do the most good for everyone whose life it touches, including shareholders but also employees, customers and other citizens.  might maximize shareholder value, but it sure doesn't maximize stakeholder value. There's a body of academic research indicating that embracing ESG principles can help increase a company's profitability. Unfortunately, that's not always the case. Often, there's a financial sacrifice. Is it a sacrifice LPs are still willing to make? Early returns suggest the answer might be no. "It seems like ultimately, it's going to come down to the LPs themselves, and the LPs are going to have to say: How do we prioritize ESG versus pure financial return? And are we willing to take less of a return in order to be positive on the ESG side?" Colaco says. "That's an easier decision when everything is good. It's going to be a much harder decision now that things maybe aren't as rosy in the equity markets."

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KKR's proof of concept KKR is a key player in Ownership Works, a nascent nonprofit that's working to give employees at private equity-owned companies a piece of the industry's profits. On Monday, the firm provided the collective with an early success story. KKR agreed to sell garage-door maker CHI Overhead Doors to steel producer Nucor at an enterprise value of $3 billion, logging a roughly 10x multiple on its original equity investment—the firm's highest-returning buyout in the U.S. in more than 30 years, per the Wall Street Journal. Thanks to an employee ownership program installed by KKR, about $360 million of those profits will go to CHI employees, including an average payout of $175,000 to all hourly workers and truck drivers.

The garage door game has proven to be a profitable one at CHI. Getty Images

Launched last month, Ownership Works is an alliance of investors and bankers that includes 19 private equity firms that have pledged to implement similar ownership programs at a small group of portfolio companies. The idea is that giving workers a financial stake in a company's success creates incentives that lead to better financial outcomes for everyone. The group was founded by KKR partner Pete Stavros, who provided some more proof of concept for the idea last year: Employees received about $500 million of KKR's $4 billion profit when the firm exited an investment in Ingersoll Rand. Private equity has a reputation for rapaciousness. And to be sure, there are plenty of buyouts that don't work out too well for the rank and file. But these days, private equity is a big, sprawling industry encompassing many kinds of deals and many strategies beyond the traditional slash-and-burn. As the original barbarians at the gate, KKR helped establish the leveraged buyout as a fearsome corporate weapon. Now, it wants to pioneer what it considers a much friendlier approach. Said Stavros: "When you invest in employees, positive results will follow."

Buying the dip It appears that a venture downturn is upon us. In some ways, it's just what firms like MBM Capital, Stage Fund and Ginkgo Equity have been waiting for. All three are venture investors that specialize in backing startups that have lost favor with traditional VCs for one reason or another—maybe growth is slowing, or maybe the target market is just too small. MBM, Stage and Ginkgo try to swoop in and restructure these companies to clean up their books and set the table for a more modest exit. It's one thing to hunt for these kinds of deals in a red-hot market like last year's, when everyone seems to be growing and funding is plentiful. It's another thing entirely to do so today, when layoffs and lowered valuations have begun to dot the venture landscape. My former coauthor Becca Skzutak may have left this newsletter. But before departing Forbes, she took a look at how these firms are navigating the VC market's shifting tides.

Apollo eyes life sciences with Sofinnova Add Apollo Global Management to the list of private equity heavyweights dipping a toe into early-stage healthcare investing.

After all, Apollo and his son Asclepius were the Greek gods of healing. Getty Images

The firm announced on Monday that it will acquire a minority stake in European life sciences investor Sofinnova Partners, part of a new partnership that also includes a commitment of €1 billion ($1 billion) from Apollo to Sofinnova's funds. For Sofinnova, access to Apollo's vast resources should allow for accelerated growth. And for Apollo, access to Sofinnova's industry expertise should create new opportunities for significant returns in a high-growth sector. Some of Apollo's rivals have had similar ideas. In April, Carlyle Group agreed to acquire Abingworth, another life-sciences venture capital firm headquartered in Europe. Back in 2018, Blackstone acquired venture firm Clarus, which now operates as Blackstone Life Sciences. Sofinnova was founded in 1972 and claims about $2.5 billion in assets under management, giving it a profile strikingly similar to that of Abingworth; the latter was founded in 1973 and manages around $2 billion. Apollo co-president Scott Kleinman described healthcare and life sciences as a "significant growth area" for the firm. Sofinnova closed its most recent flagship fund in October with €472 million in commitments.

They Said It

"This is clearly not a speed bump. This is a proper correction. The end of a cycle." —Mike Volpi, a partner at Index Ventures, speaking to the Wall Street Journal about the ongoing shift in the venture capital market

Just The Facts

— JetBlue has launched a hostile takeover bid for Spirit Airlines, taking a $30-per-share offer directly to shareholders after Spirit's board rejected a previous approach earlier this month, opting instead to stick with an existing sale agreement with fellow discount carrier Frontier Airlines. My colleague Suzanne Rowan Kelleher takes a look at how an aviation billionaire factors into JetBlue's argument for why its offer is superior. — A machine learning startup led by LinkedIn cofounder Reid Hoffman and DeepMind cofounder Mustafa Suleyman raised $225 million in new funding, per an SEC filing first found by TechCrunch. Called Inflection AI, the startup launched earlier this year, with hopes of developing tech that allows users to control computers in plain language, rather than a coding language. Hoffman and Suleyman are also partners together at Greylock Ventures. — A SPAC chaired by former U.S. Speaker of the House Paul Ryan has found its merger target. Called Executive Network Partnering Corp., the vehicle announced plans Monday to combine with Grey Rock Investment Partners, valuing the Dallas-based investment firm at $1.3 billion. Ryan launched the SPAC in 2020 alongside Solamere Capital, the private equity firm where he now works as a partner. Solamere was cofounded by Taggart Romney, the son of Mitt Romney, Ryan's one-time companion on the 2012 Republican presidential ticket. — Adani Group agreed to pay $10.5 billion for a majority stake in Ambuja Cement, a subsidiary of Swiss building materials giant Holcim Group. Led by billionaire Gautam Adani, who ranks sixth on Forbes' list of the world's wealthiest people, Adani Group is an Indian conglomerate currently worth more than $200 billion. My colleague Simran Vaswani has more details on the deal. — Optibus, which makes scheduling software for train and bus networks, announced a $100 million investment on Monday at a $1.3 billion valuation. Insight Partners, Bessemer Venture Partners and Tencent were among the investors who participated. The Israeli startup most recently raised $107 million in March 2021. — Carlyle Group signed a deal to buy government contractor ManTech International for $4.2 billion, the firm's largest takeover announced so far this year, per PitchBook. Based in Virginia, ManTech provides cybersecurity and other IT services to U.S. defense and intelligence agencies, among other clients. — Broader troubles in the crypto market didn't prevent Postmates founder Bastian Lehmann from raising a $23 million Series A round for TipTop, a new crypto startup that's still keeping most details about its operations under wraps. Andreessen Horowitz led the round, and Marc Andreessen is joining TipTop's board. — The next big logistics deal might come from Down Under. Brambles, an Australian company that supplies pallets, crates and other shipping equipment, said that it is discussing a possible takeover with CVC Capital Partners. The news sent Brambles stock up 11% on Monday, taking its market cap to nearly A$16.7 billion ($11.6 billion). — Topship, a freight logistics startup focused on the African market, raised a $2.5 million seed round led by logistics unicorn Flexport. Based in Lagos, Topship was founded in 2020 and went through Y Combinator's accelerator program earlier this year. YC also participated in the new round. — Apollo Global Management could soon offer to invest $1.25 billion in Liga MX in return for part of the Mexican soccer league's international media rights, per a report from Sportico. This would be the latest example of private equity snagging a slice of pro soccer media rights; in March, CVC Capital Partners agreed to pay €1.5 billion ($1.6 billion) for a 13% stake in the rights of France's Ligue 1.

What We're Reading

When the SPAC market roared to life in 2020, investors and bankers promised that this was a different kind of blank-check boom. Instead, it ended up looking an awful lot like booms past. (Institutional Investor) If you know Jed York's name, it's probably because he owns the San Francisco 49ers. But like the scions of many other billionaire families, he's trying to build a new reputation as a tech investor. (Financial Times) Stephen Findeisen has always been interested in debunking scams. The age of crypto has provided him plenty of material. (New Yorker) Billionaire boosters have always played a key role in shaping the fates of their favorite college football teams. Now, doing so is easier than ever. (Bloomberg) In just six years, OnlyFans has emerged as the world's top platform for self-produced erotic content. But as you can probably imagine, not everyone on the site is who they claim to be. (New York Times)

What To Watch For

When will Elon Musk walk away from Twitter? And will the company's board let him? OK, so it's no sure thing the deal will collapse—there are few sure things in the world of Musk. But it now seems like the most likely outcome, particularly after the Tesla founder tweeted last Friday morning that the deal was "on hold" until he could learn more about the volume of spam accounts on the site only to backtrack a few hours later and write that he's "still committed." Twitter stock fell 10% last Friday and another 8% yesterday; it closed Monday at $37.39, a whopping 31% below the agreed-to merger price of $54.20. Monday brought more signs of trouble in paradise. Twitter CEO Parag Agrawal responded obliquely to Musk's voiced concerns with a thoughtful thread about dealing with spam. Musk responded directly, by tweeting a poop emoji. Later in the day, while speaking at a tech conference in Miami, he said modifying the terms of the deal isn't "out of the question." And some more wild stuff will probably have happened by the time you're reading this. For Twitter shareholders, the Musk deal came at the perfect time, before a market dip sent tech stocks plummeting. But if the fickle billionaire changes his tune, they might never get their money. Contracts were signed, so Twitter can take its case to the courts if Musk balks. But will it be worth the trouble of a very expensive and very public legal dispute with the world's richest man, all to try to force someone to spend tens of billions to take control of a company he may not even want anymore? Here's guessing we'll eventually get an answer.

Kevin Dowd Staff Writer I am a staff writer at Forbes. I previously wrote for PitchBook, where I created The Weekend Pitch, a weekly newsletter about the private markets. Before that, I covered high school sports in the Pacific Northwest, and I graduated from the University of Washington with a degree in journalism and creative writing. I live in Seattle, where I read a lot of books and play a lot of golf. Follow me on Twitter.

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