Red Rocks Capital

Private Equity Continues Five-Year Run of Outperformance


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July 15, 2014  

Golden, CO – (BUSINESS WIRE) Red Rocks Capital, an asset management firm specializing in listed private equity (PE) investing, announced today that its Red Rocks Capital Global Listed Private Equity (GLPE) Index returned 21.31% per year vs. 18.82% per year for the S&P 500, for the five years ending June 30, 2014.


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Contrary to how private equity has been characterized, value is created primarily from operational improvement, not leverage.

Capital Dynamics, a global private equity firm, conducted a joint research study with Technische Universität München to evaluate value creation in private equity deals.  Their study performed an in-depth analysis of 701 exits of private equity-backed companies between 1990 and 2013, looking at sales, EBITDA, multiples, net debt, cash flows and so on.

Its findings? That leverage actually accounted for less than a third (31 percent) of the value created at these businesses during the period of private equity ownership.  “…more than half the value uplift – 51 percent – came from operational improvements, much of which was attributable to EBITDA growth (which in turn was more driven by sales growth than cost-cutting). And of the multiple expansion that accounted for the remaining 18 percent, the majority was due not to general market movements, but to improvements in the overall quality of the specific asset under private equity – which is part of the operational piece too.”



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Cambridge Associates, the alternative asset data provider, released 2013 year-end performance numbers for traditional private equity partnerships last month.  For the three year and five year periods ending December 2013, listed (or liquid) private equity provided comparable performance to traditional illiquid private equity partnerships.

Comprising a universe of over 300 firms with aggregate market capitalization of over $300 billion, listed private equity is a meaningful subset of the $3.3 trillion AUM global private equity market. In contrast to trading strategies that attempt to replicate private equity returns, the GLPE Index provides direct exposure to firms that execute the private equity business model - which is to buy, enhance and sell private businesses.


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In my last quarterly commentary (Q3 2013), I said that the state of affairs in private equity was “not too hot, not too cold, just about right.” While I am not a prognosticator, that is how things felt then and continue to feel now. Stability continues to be a very good thing for the capital markets and private equity alike.

That stability is born out of several things - low interest rates, easy access to both debt and equity, low to moderate GDP (Gross Domestic Product) growth in the developed world, continuing improvement in corporate profitability, and decent M&A (Mergers & Acquisitions) activity. Yes, the market is no longer cheap. Price multiples on deals continue to rise, along with debt to equity ratios, but not to levels that are alarming. The emerging markets appear to be slowing, albeit from high-single digit to mid-single digit growth rates; growth that most developed countries would give their teeth to be experiencing. And finally, what seems to be a constant these days - geopolitical unrest, unevenness in economic prosperity, real wage stagnation, stubborn unemployment/underemployment in almost every labor market, and concern surrounding expanding government/central bank balance sheets. All things considered, the situation is by no means perfect, but certainly good enough, especially when compared to where we were 5-6 years ago.

With the macro view out of the way, you might ask how private equity as an asset class is doing? Rather well. In fact, very well! Most private equity firms ended 2013 on a strong note and have continued the theme into 2014. The vast majority of their portfolio companies are growing revenue and/or experiencing EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) growth. They are able to raise additional equity capital in these businesses at uplifts to most recent valuations. They are selectively putting investment capital to work in new businesses. And they are exiting older businesses/investments and returning capital to LPs (Limited Partners) and shareholders (shareholders of listed private equity vehicles) at a very strong pace, which means that those private equity firms that are accomplishing the above are well positioned to raise new funds from investors, have fresh capital to put to work in new businesses, and have a new source of fee income for the private equity firm. This is the definition of the virtuous cycle in the private equity business.

I think the editor of Bloomberg’s Private Equity Brief, Jennifer Rossa, said it best in early March: “Exits, Exits, Exits.” Exits are important in the private equity world. Exits at strong uplifts to invested capital (what is commonly referred to as the multiple on investment) are VERY important. Firms that do this will thrive. Firms that do not, well they tend to wither.

While I thought about using “Exits, Exits, Exits” as the title of this commentary, Jen beat me to the punch. She gets the credit. I am stuck with using Just About Right.


I am hard pressed to suggest that things can get better for private equity, but they can. That does not mean that they will. It just means that they can. Consistent 3.5% - 5.0% GDP growth would be a good place to start, coupled with a slow rise on the 10 year US Treasury Note to 3.5% - 4.0%. Will that happen? As I said before, I am not a prognosticator, although in this case, I wish I was.

The same potential issue that I highlighted back in the Q3 2013 Commentary still holds true in a rising valuation environment: private equity may be challenged to invest capital in new businesses at reasonable valuations (always in the eye of the beholder). Why is that a potential issue? Because new capital continues to flow into the top private equity firms, private equity firms and their investors want to see that capital put to work. Chances are it will be put to work. Where, when, and at what valuation is anyone’s guess. Stay tuned.

As always, we appreciate your continued support and interest in Red Rocks and the Listed Private Equity strategy.

Adam Goldman
Co-Portfolio Manager