MACRO-TO-MICRO CIO OUTLOOK

Equistone in 2024 and beyond

After a great run of success, Ross Butler asks Oskar Schilcher, Equistone’s Chief Investment Officer, what is next for Equistone, and whether it can sustain its exceptional performance.

April 2024

RB: How do you view the attractiveness of the current market for deal-making?

OS: There is much talk about downturns being good times to buy, and that is certainly true, but there is more to this opportunity. The technical constraint in the wider fundraising market, and general macroeconomic uncertainty, have really put the brakes on the deal volumes over the past 18 months. As a result, there will be an unusually large number of assets coming to market in the coming years, once the log-jam is released. Considering simple supply and demand dynamics, it should be a super-attractive time to be a financial buyer.

RB: Do you mean from family owners, for instance?

OS: Yes, but also from other private equity firms. Limited partners will not accept them stretching hold periods indefinitely. At some point, private equity firms must find buyers to generate true liquidity for their investors. The same logic could apply to corporate carve-outs: boards are holding off on making divestment decisions until the macroeconomic picture, the buyer market and trading are more supportive.

RB: How does that idea of delayed exit decisions reconcile with Equistone’s recent exit pace?

OS: We have managed to buck the trend, realising multiple very attractive exits. I believe it is because we identified strategically attractive assets, managed to build such strategic value during our hold, or a combination of both. We’ve also needed to be creative within exit processes and spent much effort on operational improvements – but fundamental strategic value has been the main factor.

Many of our exits have been to trade buyers, to whom strategic value is, of course, always fundamental. But also, PE-buyers are currently very focused on such quality. Our most recent exit is a good example of this. Vulcain completed 20 add-ons during our ownership and established itself as the market consolidator. This allowed it to transact as one of the very few French mid-market private equity deals of 2024. It was a similar story with Amadys, with whom we completed 11 add-ons and successfully sold to PE-backed trade. The add-ons had transformed the group into a regional leader, with beachheads in growth markets that the buyer considered key.

We have managed to buck the trend, realising multiple very attractive exits. I believe it is because we identified strategically attractive assets, managed to build such strategic value during our hold, or a combination of both.

RB: If an asset is fundamentally attractive, presumably there will still be a lot of private equity competition as well as trade?

OS: Private equity buyers in general have become unusually risk-averse. Generally, only the most perfect assets are transacting, and at high prices. It appears to be a feature of investor mindsets at the moment that they don’t feel comfortable with taking on risk of any sort in an investment. Since they must transact, the tendency is to overpay on a very secure asset and just ensure they don’t show a loss. This is reinforced by the fact that it is very tough to get financing from banks. An asset with the slightest blemish will not find ready buyers in today’s market unless there is a significant situational dynamic.

RB: Does this ‘risk-off’ posture not also apply to Equistone? You are human too!

OS: Part of my role is to encourage us to continue to consider risks and maintain that willingness to be a private equity investor. Private equity is a risk bearing asset class.

History shows it is exactly in these types of environments you must retain confidence in your ability to assess and manage risk, as this is where returns will be generated. If you are fundamentally risk-off in today’s environment, you can pretty much shoot down anything. And anything else has way too many bidders, driving excessive valuations. We want to stay the course, accepting risks where we think we understand them well.

RB: The macroeconomic context may continue to be challenging. That will presumably make things less favourable.

OS: We are attracted to complexity and those instances where others are discouraged from pursuing an asset for ‘textbook’ reasons. The macro-context therefore plays in our favour. A lot of companies may be underperforming, and the ability to assess that and see how challenges can be surmounted, will have more of a premium.

Also, our reputation for being trustworthy partners, nimble in bilateral processes, and a team that is empowered to operate below the radar – all this is particularly valuable in the current context.

RB: How do you create value and what is the source of your returns?

OS: Our value creation consists of three main levers: buying well, growing earnings and developing strategic value. The dominant component is earnings growth, which itself is typically driven by revenue growth. But we also generate value from how we buy and sell companies. Very material multiple arbitrage at exit is a common theme through many of our successful investments.

RB: How will higher interest rates affect returns?

OS: It’s a truism that a driver of private equity growth in recent years has been cheap money. But even in a higher interest rate environment, if you get your entry values and value creation right, you can still deliver very attractive returns.

Our value creation has never been about financial engineering. The mean leverage on Fund VI was 3.3x, which is very low for a 2018 vintage fund. And for our previous funds it was 3.7x and 3.3x, so we’ve had great consistency on our less aggressive use of leverage, staying the course through highs and lows. That will position us well for what comes next.

Our fundamental proposition is to generate value from growth and strategic value. Fund VI’s stellar performance, and its resilience despite the changed environment, has shown this to be the right approach.

RB: Fund VI has been a huge success. But it sounds like, if you’d used higher leverage, it would have been even greater!

OS: We make a conscious decision to not use brute-force leverage as a value driver. Leverage goes both ways, as we see with the numerous restructurings now flowing through the debt markets. Our fundamental proposition is to generate value from growth and strategic value. Fund VI’s stellar performance, and its resilience despite the changed environment, has shown this to be the right approach.

RB: How have things evolved at Equistone from a fund structure perspective? Are we likely to see more continuation funds, for instance?

OS: No, I expect this to be a rare occurrence. Our Sicame continuation fund was a very specific situation, with a €300m-plus equity requirement. We consider the bar for continuation funds to be very high, but it was right for that asset at that time.

RB: What about your new Reinvestment fund?

OS: With this, we have created a vehicle that allows us to follow the success of an asset we know well with a small ticket, when we sell to another private equity firm that we rate.

Importantly, we have entirely separated the reinvestment decision from the exit decision. To avoid any conflict of interest, the buyer’s interest in the asset cannot be contingent on us reinvesting, so the exit decision comes first

This is an attractive new product: the fund is nearly fully invested and early indications are that returns will be strong. ☐

A full version of this article appeared in PLATFORM 10, Winter 2023/24