Under external fire, European private equity opts to specialize

By Reuters

Feb 22, 2015 07:08 AM EST

Outgunned by Chinese and Middle Eastern competitors and lacking the breadth of service of their U.S. rivals, European private equity firms are focusing on specific industries to compete on their home turf.

Private equity fund managers, gathering in Berlin on Monday for their largest annual conference, will weigh the potential threat of deep pocketed buyers from developing economies in Asia and the Middle East.

This group, which includes China's property and entertainment giant Dalian Wanda Group Co and sovereign wealth funds from Singapore, Qatar, Kuwait and Abu Dhabi, has become a recurrent feature of European auctions where it can beat local investors on price.

"This is a new development," said Hugh Langmuir, a managing partner at European private equity firm Cinven. "So far the incidents have been limited but it's on a watching brief."

London-based Cinven has turned the trend to its advantage by using its Hong Kong office to grow assets across Asia and negotiate rich exits such as the 900 million pound ($1.4 billion) sale of British restaurant chain Pizza Express to Chinese private equity firm Hony Capital last year.

For those firms seeking an exit from a business, like in Cinven's example, widening the pool of possible buyers has made the process more competitive and secured a higher price.

"Having a global team and expertise in helping companies expand into new markets are strong differentiators," said Luca Bassi, a managing director at Boston-based buyout fund Bain Capital.


While some of the major U.S. funds such as Blackstone and KKR have diversified their investments across several asset classes, providing anything from alternative asset management, real estate and hedge fund solutions, European firms have been reluctant to tackle new business areas.

Many of them believe that specialization is the way forward.

In Europe where smaller to middle market deals worth between 500 million and 2 billion euros have become the mainstay of the industry, specialization is even more compelling as blockbuster deals have been harder to execute.

"If you are a mid-market generalist investor in Europe, you will want to develop a specialism quickly, or you may struggle to differentiate," said Joseph Schull, a managing director and head of European operations at private equity firm Warburg Pincus.

Some European mid-market firms have started raising "thematic funds" focusing on areas where they see high returns such as consumer, media and technology.

In Britain, consumer-focused private equity firm Lion Capital, which backs Britain's high street retailer All Saints, is preparing to raise its largest buyout fund to date worth about $2.5 billion, a source familiar with the matter said.

"There is no market for generalists in Europe," the source said. "It's a natural selection."

The need for specialization comes after U.S. behemoths such as Leonard Green and Providence have spent more than two decades targeting the retail and media industries, respectively.


European buyout funds seeking new money to play with are also having to deal with pickier investors, known as limited partners, who need a strong investment story, wary of paying several hundred millions of dollars in annual management fees.

Since the start of the financial crisis, private equity firms and their managers, also known as general partners, have seen the average amount of these fees dropping globally from 2.5 percent to around 1.5 percent of the committed capital.

Mid-sized funds have readjusted their fee structure to around 1.75 or 2 percent of the committed capital.

Fabio Sattin, chairman and co-founder of Milan-based Private Equity Partners, said there were clear differences between limited partners and general partners on how to allocate fees.

"Investors want fees to be more performance-related and are reluctant to pay fees when the pace of investments slows down, especially during a downturn."

While management fees remain a key source of income from private equity firms who use them to pay salaries, business trips and rent, other kind of fees, such as transaction fees charged at deal completion, have become less popular.

"The secular shift in the balance of power between limited partners and general partners has begun to make the industry more transparent about how firms make money, which is a good thing in itself," said Warburg Pincus' Schull.

The clampdown on fees has prompted a series of direct investments whereby limited partners have run solo or teamed up with buyout funds to back the purchase of pricey assets, paying fewer, if no, fees to general partners.

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