A Conversation with Cobepa CEO Jean-Marie Laurent Josi – What’s Next for Private Equity?

Thierry:

I am delighted to launch today, a series of videos on the mega trends in the private equity industry with Jean-Marie Laurent Josi. Jean-Marie is the Chief Executive Officer of Cobepa, a leading privately held investment company headquartered in Brussels, with offices in New York and Munich. Jean-Marie, on behalf of White & Case, a very, very warm thank you for having agreed to share with us today your views on the mega trends impacting the private equity industry. And let me start with a general question. The private equity industry has experienced significant growth over the last 20 years, but also more recently, faced some turbulence with high interest rates impacting dealmaking and exits. What is the way forward?

Jean-Marie:

Thank you, Thierry.

It is my pleasure to be here with you.

And indeed, your general question is a very specific one. And probably a very interesting one. So before answering of what the future could be, let us have a look on the past for one minute. As you rightly said, the private equity industry has experienced a very strong growth the last 15, 20 years.

That growth can be explained by basically four elements. This is quite simple. The first one is that private equity is efficient for the companies in which it invests. It is smart money, fast action and often entrepreneurial money. The second point is that it has been a profitable investment for the investors. So, the private equity industry has delivered a return which has outperformed the stock market during that period.

The third element is that the private equity industry adds and still has some room for growth in the overall equity financing of companies at the expense of the stock market. And the last element, which is a very important one, is that especially during the last 15 years, we have experienced an environment where interest rates were going down. This has led to an almost absurd situation where the money was almost for free, especially when you were in a position to borrow money.

Now, since the war in Ukraine, the backdrop has completely changed. And indeed, it has been very clear that in 2023, the activity of the private equity industry has dropped materially. So, the volume of the transactions dropped by 60%. And this is quite consistent between Europe and US. Why was that? The war in Ukraine as one of the consequences, the fact—generates the first wave of inflation since 20 years.

And when we say inflation, we say interest rate increase. But the private equity industry was no more equipped for handling that situation while the stock market adapted themselves quite rapidly to that situation. In a few days’ time, in fact. And one year apparently was not even enough for the private equity industry to adapt itself to that situation.

For me, there is no doubt that during that period, ‘22/’23, the return, the risk-adjusted return of the private equity industry has deteriorated. And now, we are very close to the moment of truth. Why I’m saying that is for one simple reason. I do expect, and I think you have the same indicators, that there will be a lot more volume of transactions in the market for the coming 18 months.

The reasons are very simple. The market has been frozen, and now private equity firms must sell assets if they want to raise new funds. And so, the point will be to see if they would be able to sell these assets as a valuation, which enables the industry to deliver that expected return to their investors. And this is far from being sure.

And more globally speaking, we need to see what would be these valuation levels, and to what extent they are aligned with the multiples, which are the one of the stock markets. And basically, I see only two options. And the first one is that we are progressively, but surely coming back to a situation where the market is sound again.

What does that mean? Risks are priced correctly. Free cash flow is coming back again as a key component of valuation. Equity cases which are underwritten reflect a healthy balance between risk and opportunities, and the leverage which will be put in place doesn’t put the company in a stressed situation. This would be the ideal scenario, but I think that scenario doesn’t have a great chance to become what will be the future.

And so, this leads me to the second option. And the second option is there because the private equity industry in the last 20 years has fundamentally changed. Many of the main GPs are now listed. And if you are listed, in fact, you are, by definition, becoming and acting like an asset manager in private equity.

The day you are an asset manager in private equity means that what drives your own valuation is the management fees that you are able to earn. And to maximize these, you need to maximize the size of the assets that you are managing. And to maximize the size of assets that you are managing, you need to deploy money. And this will support the valuation, probably at a level which is not really sound.

So, when you are talking with players in the market, they will tell you, rightly, that the market will be somewhat more discriminating and that this high level of valuation will apply to the so-called “strong asset.” But everyone knows that a strong asset, which is, which would be paid at too high a price, become a weak asset.

It's very simple. And we have seen, and there already many examples that sectors which were seen to be immune or very well protected, have seen their multiples experience a substantial de-rating the last three to four years. So, there is no asset class within the private equity sector which is immune. And so, the risk still exists, that the risk-adjusted return will not come back to a sound level.

Now, having said that, there is nevertheless one positive point that should not be underestimated. And that positive point is that the private equity firms can attract good talent, and with good talent, you can enhance your level of conviction for doing or not doing deals. And so, it means that, in fact, the barriers to entry in the industry are coming higher and higher because either you have those talents or you don't.
If you don't have these talents, you will be in a situation where you will see risk everywhere and you will be unable to raise your level of conviction in order to enable you to put a valuation at which you can make the transaction. And so, at the end of the day, we should never forget that a valuation must or should at least reflect your level of conviction.

And you should never forget that the wrong question when you are in the private equity market, is the one of what is the price that I need to put on the table in order to win the deal? The right question is, what is the price that I can put on the table, which is in line with my level of conviction?

And if the market tried to be disciplined that way, then maybe we can afford the risk, which is very clear. There is a risk of a bubble. And in the financial industry, a bubble can last a few years.

Thierry:

Thank you, Jean-Marie, for those very insightful comments. I would now like to move to one of my favorite topics: Sustainability and ESG. Environmental, social and governance considerations are becoming central to PE investment. Is this a temporary trend or to the contrary? Is it becoming part of the criteria of sustainability of businesses?

Jean-Marie:

I don't think it will be a temporary trend. I think that sustainability and the whole ESG environment is something which has to be part of how to do business in private equity. Now, what you could see in the future is that the so-called impact terms will probably be less relevant because everything that you do must have an impact in a way or another.
So to be different, just say that you are an impact fund. Probably just a way to tell your investor that you will invest in probably more the venture capital part, and that you are looking to industries which have a direct positive impact to the environment. But the overall private equity industry has already engaged in a process, in a trend where sustainability is a key component of the risk assessment, but also on the opportunities assessment of each investment. And I really do believe that that trend will not disappear.

Thierry:

In recent years we have observed a notable trend, i.e., that smaller PE firms have been acquired by larger investment companies or have chosen to merge with other players. This dynamic raises a question which is, are we now moving to a stage of consolidation within the private equity industry?

Jean-Marie:

I'm not sure that we can use the word of consolidation because the private equity industry is one where new firms will also continue to emerge. But you are right to say that there are several elements which lead to a situation where you will see some private equity firms to be acquired by others.

So let us just name these elements.

The first one is connected to the asset management trend of that industry. And you have seen that many firms have decided to expand in other class of assets: private debt, real estate, infrastructure. And the best way to do that is to acquire GPs, which are specialized in these verticals. So that is one reason.

The second reason is that some private equity firms have experienced generation movement. And one way to solve that issue is to sell the shares of the GP to another player.

And the third element, which I don't think will be the main one, is probably also because some private equity firms have seen their return not in line with those of what they promised to the investors, and therefore they have some difficulties to raise new funds. And again, one way to solve that issue is to start thinking about how to consolidate with someone else.

Having said that, if you would ask me, what does that mean that the number of players will decrease? I don't think so. Because in these mega firms, you will see some teams creating these firms, setting up their own firms.

Because, you know, agility is very important in private equity industry and these mega firms sometimes are becoming somewhat too heavy, and probably not always in line of what companies do expect.

Thierry:

Thank you very much, Jean-Marie. I think it was a great session.

Jean-Marie:

Thank you, Thierry.