by David Rogers.
Adrian Warner is experiencing deja vu after another long bull market driven by easy money.
The chief investment officer at high-performing global value fund manager Avenir Capital remembers well the heady days of 2006 when as Asia-Pacific managing director of CVC Capital Partners, then the biggest private equity fund in Asia, he worked on the hotly-contested Nine deal.
“We were told a price — James Packer said it’s 11 times EBITDA — and it became this mad, frantic and immensely complicated race between CVC, KKR, TPG and Providence to get there first with a fully financed and structured multibillion-dollar deal for assets that were already structurally challenged,” he said, adding it was a process that was “very well run if you were a seller, terrible if you were a buyer”.
It was symptomatic of a time when private equity was desperate for deals and the downplaying of risk. In his mind every asset class was “deep into irrational exuberance”.
Warner had felt that way for some time. He tried to leave the private equity world but was lured back and convinced to stay. It was a case of, “OK the world’s gone mad. It’s time to get out.”
PBL Media turned into something of a poisoned chalice for CVC, which like many of its peers was burdened by high debt levels and underperforming assets after the global financial crisis.
Warner thought at the time James Packer was asking a pretty full price for debt-laden and structurally challenged businesses, if not ringing the bell on the entire bull market.
But that was pre-financial crisis, and private equity groups were clamouring for a piece of the action.
Now he sees the private equity industry often forced to pay similar earnings multiples to those of 2006 as it scours the globe for opportunities to deploy a staggering $US1.8 trillion ($2.6 trillion) of “dry powder” uninvested funds.
That remarkable war chest has been accumulated over a decade of record-low interest rates and quantitative easing that stretched valuations around the globe.
Warner doesn’t miss the private equity game.
In his mind, private equity had passed its heyday because, like any asset class that does very well, it attracted huge amounts of capital and competition for deals that lowered returns over time.
When he started in 1994, the biggest private equity fund in the world was a $US2bn KKR fund and CVC’s last fund was about €16b ($26bn) in Europe alone.
“Back then you could find really interesting deals at attractive prices,” Warner recalls.
“Fast forward to pre-GFC and you had this irrational behaviour.
“The same thing is happening again now. The past 10 years have been great for private equity because asset prices kept marching up on central bank liquidity, but private equity prices are now at record levels.
“Funnily enough, the average multiples that they are being asked to pay now are the same as in 2006.”
Of course, Warner is still a big fan of the private equity approach and says their model has merit.
“There has been in the past a perception of private equity as starving companies of working capital, ripping all the costs out, and taking muscle as well as fat off the bone,” he says.
“Obviously the model has got merit — having a clear strategic and operational focus and putting the right incentives in place is important.
“But when you’re buying off them [private equity] at very full prices now, I don’t think that’s a great thing to be doing.”
But by using a similar
value-orientated approach to identify companies trading significantly below their intrinsic value, Avenir holds a concentrated portfolio of companies in the public markets.
Warner says that by replicating private equity strategy in the public markets he’s finding many more profitable opportunities than he would if we were still working on the other side of the fence.
Part of the Fidante Group of boutiques, owned by Challenger Group, Avenir has returned 19.3 per cent per annum in the past three years and 16.3 per cent since inception in 2011.
Warner says he shuns most of the companies that private equity dresses up for sale to the public market these days, though he sometimes invests in what he calls “broken” IPOs.
Adairs was one such bombed-out private equity float Warner did well from after buying after its shares plunged after failing to meet lofty IPO guidance.
But Avenir’s highly-concentrated portfolio of 17 companies — indeed most in the companies on Warner’s watchlist of about 400 — are based overseas.
“Quality is very important to us,” he says.
“We look for companies with durable competitive advantages — but we always want a ‘mispricing’ and an IPO is not an example of that. But an IPO that has disappointed early in its life in the public market and you get a very savage reaction from those early shareholders, that often creates a very interesting mispricing.”
Warner says an entire generation of investors have experienced global markets that have been underpinned by central banks cutting interest rates, increasing leverage, and relative geopolitical stability.
In his view those tailwinds are becoming headwinds.
He warns that, with global markets now in the top decile of valuations historically, equity investors should expect returns of only 1-2 per cent per annum for the next decade.
“People need to think about the next 10 years in a different way than they’ve been accustomed to over the last 30 years because the tailwind of increasing asset prices will not continue,” he says.
But, while equities could be “somewhat hamstrung” as central banks reach the limits of effective policy stimulus, he expected plenty of opportunities for great returns due to the opportunities provided by “mispricing” in the public markets.
He notes that in year to
mid-2018, a third of S&P 500 companies saw their share price change by at least 50 per cent, while three-quarters saw their share price change by at least 30 per cent over a year.
In his view their underlying values are not swinging by that much over a 12-month period.