February 1, 2012
Interviewed by: David Snow
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Supply, Demand and Tears

The 2011 private equity fundraising market began with high hopes but ended with investor fears about the outlook for Europe. According to Mounir “Moose” Guen, founder and CEO of MVision Private Equity Advisers, capital originally earmarked for Europe is about to flow into other areas of the private equity market, with the U.S. middle market a big beneficiary.

In an exclusive interview with Privcap, Guen details the fundraising markets of Europe and the U.S.

The 2011 private equity fundraising market began with high hopes but ended with investor fears about the outlook for Europe. According to Mounir “Moose” Guen, founder and CEO of MVision Private Equity Advisers, capital originally earmarked for Europe is about to flow into other areas of the private equity market, with the U.S. middle market a big beneficiary.

In an exclusive interview with Privcap, Guen details the fundraising markets of Europe and the U.S.

David Snow, Privcap: So Moose, welcome to Privcap.  Thank you for joining us today.

Mounir Guen, MVision Private Equity Partners: It’s a pleasure, thank you, David.

Snow: Your business is fundraising. I think everyone is aware in the private equity market that fundraising has gotten a lot harder. But I’m interested in drilling down into what that means.  It can’t possibly be the case that every single strategy is going to find the same level of difficulties. I’m interested in learning from you where the supply and demand mismatches exist and whether that spells opportunity for certain kinds of managers.

Guen: Well, I think we have to look – 2011 was an interesting year because it started off with a lot of buoyancy to it, where investors had been holding back because in ’09, investors were not active; in 2010, there was not enough supply in the marketplace. So in the beginning of 2011, it looked like everything was coming together. Capital was available, quality groups were coming to market, exits were happening, markets were stable. Then we started getting news items – Greece, other areas of Europe, the US re-rating.

Snow: Events.

Guen: Events that took place, which meant that all of a sudden the exits slowed down.  But more importantly, the capital markets, the banking system, was again uncomfortable. The liquidity started fading out of the marketplace. Valuations were again put into question. The activities halt, and so now it’s coming back or is back very selectively, and what we see happening is a very interesting situation where, at this particular time, track records, because they had built a fair amount of unrealized portfolios, still need to be able to shed those investments. The track records that they have have not been completely developed. So an ability for joint partners to look to postpone to come to market is again coming into play.

Investors are, like I mentioned, being very selective at this particular time. They are also taking now macro-views. So one of them, for example, is this discomfort with the European dynamic. What does that mean? That means exposure to Europe will be decreased by 20 to 30 percent. But it’s still there, right? However, if you look at the European landscape, you will see that there are a number of funds that are in the market that are probably labeled to be at the higher end, using 3.5 billion dollars as a gauge for the cutoff point as where there is some selection of general partners that investors are working through.

But when you’re looking at the sweet-spot of the market, the 750 to the 1.5 billion, there’s very little product. The capital that is being put aside from Europe is looked to be put into a rest of world. And without a shadow of a doubt, David, every single portfolio of every single investor is looking to increase their rest of world – I use that terminology for meaning new markets or emerging markets, whichever definition you’d like.

Snow: So not moving – not Europe’s loss is the US’s gain; that slack is being picked up in rest of world ex-Europe, ex-US.

Guen: Oh, we’re gonna get more interesting now. Only yesterday I spoke to a public pension that was moving their program two and a half times in exposure in their private equity allocation. A lot of them are moving towards a 20 percent number in terms of the allocation for emerging markets or rest of world allocation. Now here’s the underlying dynamic. What you’ve got is very exciting because you’ve got mature programs, very sophisticated investors, who are looking with fresh capital and a large area of the world – very exciting.

On the other side of the equation, you’ve got new investors that are coming to the market who are also going straight out of the box with a 20 percent, 25 percent allocations rest of world around the box. So you should imagine that this means that there is a certain buoyancy in access to capital. Again, we don’t have the quality general partners accessible to be able to take in that capital. So again we have a dearth of product.

Ultimately, what happens is that the US investor, which is the main source of capital – the state municipals in particular for 2011 – will look at Europe, draw back a bit, interested in an area of the market that doesn’t have product, look to put money or capital to work in emerging markets where there is a limited selection, and the selection they do have cannot get the allocations they want because these funds have pile-on effects. The moment they come to market, everyone wants to get into them so they get too big and actually start deviating from strategy, which then makes investors go away.

Or they stay disciplined and you can’t take any more new names in because the existing crowd out because the existing have increased their allocation, you see? And so the net net of all of this is that that money will come back to the United States. And the US general partners that are in that 750 to 1.5 billion space will find themselves very popular. We’ve just witnessed this in a situation that’s very personal to us, where a fund in that space was literally done in less than two months. Now don’t get me wrong; this doesn’t mean that there’s no work. There’s a lot of work still around the fundraising because the investors are more thorough, dig deeper into unrealized portfolios.

You produce 5,000 pages of information for each investor in terms of their diligence process; they’re still there. But they’re willing to work in groups, they’re willing to work in a more streamlined timeline that as long as they’re taking the box –  And they’ve got nothing else to do because there’s no other produce elsewhere. So where in 2011 it was the investors’ time and the investors dominated the term negotiations, we could see early 2012, at least the first half, with limited product in the number of segments and regions in the world where the funds are so popular that the game becomes internal partners strength on the term discussions. So it will be very interesting going into 2012.

Snow: Well, sounds like this is bad news for just another European private equity firm, very good news for an experienced emerging markets manager, not good news for the less experienced emerging markets managers, and good news for many, many veteran participants in the US middle market.

Guen: Correct. But I wouldn’t say that the in Europe it’s necessarily as negative, because again, there’s that lack of products. So, if I was committing a billion dollars to the European marketplace and I cut that back to 800 or even 700, that’s still 700 million that’s looking for a home. I’d like to do one or two of the larger funds, maybe three, but then I’d like to put the rest in what I label to be mid-market, which is this 750-1.5 as a gauge. I can’t find it.

Snow: Who’s going to feel the pain in Europe from a down-tick investor interest in allocating to that region?

Guen: Well, it’s not so much the down-tick. What you’re looking at is you’re looking at the level of activity. So one of the things I said is that funds in the 3.5 billion dollars above will – the investors will choose some, not all. But the more complicated technical aspect of that part of the marketplace is a term that I will have copied from somebody that I heard him use in a conference I liked very much, which is mortality and melt. And so if you have 40 investors that dominate your fund’s funding and 37 of them return, you’re doing great, the mortality is low; that’s good news. If you have mortality as a 40 to 50 percent, you’re going to be in big trouble.

However, there are funds at the larger scale because the mega-investor has gone from writing a ticket of 500 to 150. You have melt. So even though your mortality is low and you look good on the books in term of your re-up rate, the ticket sizes aren’t the same.  So as the fund sizes get larger, the melt becomes a larger component of the dynamics. And that can only be filled by new investors or staying in the market a bit longer to pick out a couple of vintage allocations.

Snow: You talked about how investor interest in, let’s say, rest of world emerging markets was not being matched by a supply of quality managers.  But isn’t it the case that when many investors say, “I want to invest in Brazil,” and the most well-known experienced team is not raising a fund or is already all full-up with capital, they some investors have a tendency to just pick the next best group. And so won’t there be benefits to, although perhaps not recommended, won’t there be benefits to groups that haven’t quite established themselves, and now, because of the lack of products, are being given the chance to get capitalized?

Guen: I call it the lesser evil effect. And so where investors have very high criteria of very high selection in Europe and the United States of equivalent standard, sometimes, to be able to gain that diversity, they would like to have access to a general partner in the marketplace where they will be a little bit more open in their selection process.

First of all, I believe that private equity is not a regional game; it’s a people game. And so you need to be able to believe in the managers with whom you’re giving capital; it is very important that you select the best managers to give capital to. So never, ever compromise your criteria because you’ll only end up in tears. So a big warning to those people who are doing what you just said.

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