Jeffrey D. Montgomery, managing partner of GMT Communications Partners, examines the market outlook for media and telecoms investment and calls for a ‘back to basics’ approach for private equity investing in which returns are generated by deeper industry and operational knowledge as opposed to financial engineering.
With commentators vying for the title of Most Pessimistic on the Outlook for the Economy 2009, it would be brave indeed to suggest that it’s not all doom and gloom. Clearly the prevailing lack of capital is negatively impacting transactions and investment generally. Soon, December valuations will replace current, September valuations and reveal the stark fortunes of many private equity portfolio companies.
But in spite of this, limited partners are maintaining their allocations to the asset class, with a recent Coller Barometer report suggesting that more than a third of LPs are planning to increase their commitments to private equity in 2009.
The challenge for general partners is to ensure their investment model can deliver the attractive returns LPs are looking for. Leaving to one side the issue of previous performance, investors will be closely scrutinising fund size and investment focus, with an eye to overall risk as much as potential returns.
Following the major fundraisings of 2006 and 2007, large-end GPs absorbed the bulk of LP allocations to private equity. Investors were attracted by the possibility of diversified and therefore de-risked portfolios, as well as by the administrative ease of investing their allocations in larger packets.
But with leverage for large transactions nowhere to be found, large-end GPs are increasingly looking to diversify beyond their proven investment strategies into smaller transactions in untested sectors or markets. At this point, when it comes to predicting future returns, all bets are off.
The solution is for GPs to stick to their onions. And in the current climate, funds that have always operated in the mid-market and succeeded in maintaining a clear investment focus will find it much easier to do so.
Proven specialist funds in areas such as distressed and turnaround, mezzanine finance, or particular industry sectors or geographical regions will continue to outperform thanks to a deep knowledge of their market.
Even if this is out of favour, they know which sub-sectors continue to offer investment opportunities; they know when not to invest as well as when to invest; they can continue sourcing higher quality investments, and at more favourable rates.
While finance providers will maintain their confidence in their investment decisions, management teams and vendors will continue to support them as investors, and acquirers will continue to trust the quality of their investments. Lastly, LPs will know that their money is being invested wisely.
The best returns can be achieved following market corrections, and a well-thought out strategy can reap rewards even in a difficult economic environment. Sector funds will be best placed to identify high-quality risk-averse investments in this market, where pricing, in particular, remains difficult to clarify. In a difficult trading environment, specialising offers less risk than diversifying.
Similarly, the exponential growth in providing customised proprietary information and data to business users will allow for equity-only and development capital deals of considerable size. And, of course, while 50 percent of the homes in Europe have high-speed broadband access, 50 percent still don’t, which represents a considerable ongoing opportunity for capital investment in an attractive sub-sector.
Innovation is the key to success in media and telecoms, and investors need to stay one step ahead if they are to make good investment decisions. And the secret to staying one step ahead? Sector focus. It’s ‘back to basics’ for private equity investing, where returns are generated by deeper industry and operational knowledge, not by financial engineering.