The opaque world of private equity is beginning to have the torchlight of regulation shone in its direction.
Rather than resist, there is an opportunity to work with the financial referees and to bring in a fair framework for everyone to operate within.
An article in Business Week at the end of last month alleged that PE firms were “running unchecked”. Four areas were criticised: huge dividends and fees; serial charges; debt bombs; and quick flips.
This week, the UK’s Financial Services Authority warned that a collapse of a large buy-out was now “inevitable”. It worried that a flurry of deals going pear-shaped but even destabilise the economy.
With global deal volume of $570bn for the first nine months of this year alone, PE is very big business and has the potential to wreak havoc if things go badly awry.
But such fears have been expressed before and the reality is that while the collapse of deals can cause market jitters, there have been no lasting effects other than on the burnt investors directly involved and a little more caution all round.
A popular point of view around the collapse of Le Meridien was that such debacles are necessary to call the top of the cycle. Unless mistakes are allowed, the market will remain inefficient.
The US Justice Department is also looking into anti-trust issues with regard to PE deals. Hopefully, the US authorities will resist the sledge hammer and nut approach that led to Sarbanes-Oxley. The lesson from the introduction of these laws is surely that too much interference simply hampers market clearing.
For example, the much criticised quick flip is simply somebody opportunistically grabbing what has been left on the table. Public equity investors have been either unwilling or unable to account for the huge valuation gap between a the value of a publicly listed hotel owning company and the value put on the same property outside of the stock market. PE firms simply closed the gap, with a little leveraged help, again making the market more efficient.
Arguably more concerning is the way cash is being extracted early into a deal’s life, often via both fees and big dividend payments. If a PE firm is being paid simply for doing the deal, the motivation for striking a good deal begins to be outweighed by the need to strike any deal.
Here, the debt financiers had better look closely at the terms of the equity financing and equity co-investors have to be sure that their interests are fully aligned with the leaders of the deal.
Ultimately, however, PE firms’ ambitions will be their undoing. There simply are not enough deals of the type where extraordinary returns can be made. The flood of money heading into the pockets of PE outfits will dry-up as their returns slump back to that achieved by more conventional, institutional, approaches, ones that gobble up far less in fees.
The ones staying the course are likely to be those that have taken the time and trouble to assemble teams of experienced executives, familiar with the hotel industry. Only through industry expertise can the real opportunities be spotted.
To these ends, it was a welcome move to see Morgan Stanley Real Estate announce this week the hiring of Andre Martinez, the former CEO of Accor’s EMEA hotels division. The 25 years of experience Martinez has in the hotel sector will be employed pulling together MSREF’s global hotel interests under the banner of Panorama Hospitality, the moniker used until now for just Asia Pacific.
Martinez will be chairman and is being joined by Peter Henley, previously head of business development at Raffles Holdings. MSREF’s European interests include the recently acquired seven InterContinentals and the Mandarin Oriental Prague, the latter was acquired at the end of last month with the help of Cedar Capital Partners.
This is just the sort of long-term approach that should satisfy the regulators. With a little more disclosure on fees and debt structure, then PE firms should be able to see off too much interference.