The relatively high return on equity that private equity achieves in comparison to the other forms of investment is often connected with higher risks. Private equity investor seeks value where others do not. In the current crises, this might become even more evident, than ever before.
Where and how to invest is becoming a very obvious question, daily challenged by the media and number of analysts. In the environment, where it is tough to predict what happens next week, the easiest answer appears to identify sectors, most immune towards the crises instability. To focus on the production and services that can not easily be cut from the expenses of customers or consumers e.g. non-luxury goods and services, food retail, energy, or health care might be immune enough to suffer from the global decline in consumer spending. However, these sectors bring serious obstacles for private equity investors ready for acquisitions. Why?
As they become popular, there is a strong competition among investors that increases price expectations. In general, the sellers are not willing to sell, if the companies generate sufficient cash-flow, moreover, there are no fire-sales. So, in times when investors are demanding higher returns because of the crisis, there is a clear miss-match in the discussions about the fair value of the respective company. There are 2 scenarios from this situation: 1. the price gap between the different expectations is too high and the parties simply do not agree or 2. the selling party understands the need of a financial partner these days and negotiates the conditions that are still acceptable and bring him fresh capital that will move the company into other levels – increase market share, acquire depressed competitors, invest into new product or technology and gain further competitive advantage. There is a big difference among private equity groups. Some of them are pure financiers, who just bring money to the table, some are more operational and hands-on and thus become partners in business. The second is much appreciated these days when market changes every day and old business lectures/wisdoms do not work.
Unlike them, the sectors, suffering the most from the global decline might bring hidden unexpected values for those able to edge their risk sensitivity further than most of the market. The sellers in a number of industries as machinery, construction, or car composites production experience different mood. There is stress, price expectations significantly lower, though risks higher. For an investor it is crucial not to buy everything, or the cheapest, but buy smart. The targets are companies with some specifics as tendency towards cost leadership, best services, or technological exclusiveness, which might benefit from a decline within their industry and achieve growth by squeezing their competitors. It is important, that the decline by 20-40 % does not mean that everything gets stopped. It means that chance to survive will be for the most efficient ones.
In Penta, we have recently entered to two of such kind of problematic sectors, the acquisitions in the meat industry in Hungary and Slovakia and the window industry in Poland and Slovakia. Although these sectors are the ones which are affected by the crisis significantly, we intend to use our financial power to create the number one player in each of them through multinational holdings able to benefit from the maximum operational efficiency, synergies and savings of scale, thus reach growth, though the industry is in decline. The key will be the cost or product leadership, robust company structure, strong balance sheet with low indebtness and right management that can guide the company through difficult times. Penta is known that we interact with the managements on a daily basis, support them, help them and jointly discuss strategic but also key operational issues. We work as a team that wants to win in any times.
Our approach that is that unique and different from other investors will be tested in following years.
Jozef Janov
Local Managing Partner in Poland