Private Equity Analysis is a Joke
MFPE for 2 years now and comical how serious people in this industry take themselves / drink the Kool Aid. Here’s a few reasons why the majority (i.e., clearly there are outliers) of PE funds have limited alpha and why PE is comical.
PE Diligence is extremely elementary analysis. Can call it “data cuts” or use whatever fancy buzz words you want, but there is very little to no insight generated. You will then be asked to model with insane precision 2032 R&D. VP and Principal will debate what numbers to use while quite literally not being able to granularly explain what is even included within R&D. You will then have to reoutput a 70 page briefing deck 3x because of this. Yeah sure, I guess 20% as a % of revenue “feeling reasonable” is stellar diligence and as they say, “gaining comfort on the asset”.
It’s legitimately shocking how much even Principals/Partners rely on model numbers and believe their firm actually takes a “data driven approach”. Modeling is a bunch of child’s play and mental masturbation, and how anyone takes it remotely serious is unbelievable. “wE mOdEl nOt tO pRedIct tHe fUture BuT tO uNdErstanD kEy LeVers”. Okay buddy, sure, guess we clearly didn’t understand the key levers as well because we’re off our IC projections by 30%. If we’re solving for a 20% IRR and 15% revenue CAGR anyways, why didn’t we just hardcode revenue and EBITDA rather than build a granular 5K row bottoms up excel model?
You similarly can’t convince me that anyone who paid 7-8x Revenue for a business in 2021 and underwrote an exit at the same 7x revenue multiple to meet threshold returns (and had this somehow approved by IC) has even average IQ.
The most comical is “benchmarking”. I’m not going to even start on this one but yeah sure let’s compare a government software business trading at 30x to our business to justify our high exit multiple (and legitimately convince yourself there is any parallel in business model, industry, etc).
Being less cynical, I understand that at its core PE has difficult aspects (and that the job inherently changes as you become senior, and I really do think the job as a principal/partner is quite difficult), but it’s all this “masquerading” and false precision as it pertains to financial analysis/diligence that I find absolutely ridiculous. In some ways I am respecting VC more and more though it’s a completely different game - quickly find conviction in founders, business model, and base unit economics, and act quickly. None of the endless BS of PE.
There is no edge in diligence in PE - anyone with capital can purchase a decent business with cash flow and get 2.0x MoM. Every fund in a process will do the same analysis, and the difficult aspects of PE and more broadly what makes a great investor, is much more qualitative. And let’s not pretend our value creation initiatives actually do anything except give our own uneasy minds comfort that we’re “contributing”.
We are almost just as much of a commodity as bankers - capital is our only value and commodity. Tell me why i’m wrong.
Separately - for the folks who have exited PE to HF, how much more difficult / pointed is HF analysis versus PE? And if so, how difficult was it to actually pivot / ramp up in this?
Sir I just wanted to know if you were ok with 2% milk in your latte
Lol not to hijack, but I do infra investing with a focus on renewables and its even worse than traditional PE which is what you do...In infra, we primarily compete on cost of capital when entering auctions / competitive processes... as an example, if you're bidding for an operational wind asset with a PPA locked in for next 10 years and a useful remaining life of 15 years, not much creativity you can inject into your bid. you either bid the book, which is common, or assume a bunch of standard levers (repower the asset to extend the useful life, try to recontract at a higher PPA price and potentially vary contract / merchant exposure which comes at the expense of leverage, some minor O&M related savings)...that's literally it. And modeling is so tedious, we're building monthly models over 30/35 years....I am guessing other infra asset classes would be equally tedious and boring...The good thing I find about infra investing is less scope to indulge in BS analysis vs. tradational PE and potentially less DD to do....
PS - I know I am skipping early to late stage development assets, but slap a $ / W to them for valuation, and read their permit / lease / interconnection docs to confirm management's claims...what else will you do...
You don't outsource the actual building of the operating models to your bankers? Obviously as a PE grunt you have ownership over the model but the tedious work of actually building out the model is something I gladly hand over to our bankers (albeit I am on a utility corp dev team).
This depends on the firm. Many do outsource the grunt work to an advisor but some firms do it all in-house (not ideal obviously if doing it mainly or all in-house but many smaller shops or new shops function like this since not on the radar and/or constrained by financial resources). Heard some sad but funny stories of PE associates getting worked on the weekend or Friday night to conduct heavy market research and slides on it, and another sitting around doing primarily LP accounting/FP&A/portco work (to name two examples)…
Thanks for the insight !
This is why I do earlier-stage renewables investing - that is, I invest in the developers who will then flip you their stuff at $x/W. We add a lot more operational value during the project development process, making sure budgets and timelines are following best practices and killing projects earlier than our developers want us to when it's clear they've gone south. This is super interesting and demanding without requiring typical PE sweatshop hours or processes.
When we approve a project for development kickoff with a development budget of $XMM (because as control investors we are the developer portcos' "internal IC," so we have to sign off on every project they originate), we just accept that the model (which is used for our own development multiple + a next-buyer IRR calc) is directional only and we have to keep re-underwriting the project as power curves, interconnection timelines, capex assumptions evolve to check whether it is still viable before we go out and sell it to a strategic or an infra fund ~6-12 months pre-NTP. More art than science, but we try to be intellectually honest about it.
EDIT: To be clear, my pay is also not typical PE pay. No such thing as a free lunch! I am 1 year out of my MBA, 225k total cash + 50 bps annual profit sharing (as my employer is technically a holdco/platform, not a closed-ended fund, so no waiting for carry to vest). I get to do cool shit and work maybe 50-60 hrs a week, so for me it's a great arrangement. Will be pushing for VP promote in next 12 months.
This sounds like fun. Did you get into this role straight after MBA? Mind sharing the peer companies of your PE? I'm targeting these kinds of funds, need to dig deeper.
Hi CJ,
Your job sounds like something i might be headed for, I'm starting out in FoF PE.
Mind sharing valuable skills (Technical or other) that allowed you to land your role?
lol are they making you create a data pack on a Sunday ?
I partly agree, in MM - but we do get into the unit economics of things - and this where you can actually benchmark things better. For example, in social care - we can benchmark the average fee per resident or so to see if its reasonable vs. target.
Although, you typically end up with the 'high level' paper LBO with % uplifts / % margins being like 85% good enough... but still - it is possible to go deeper.
Maybe it's a sector team vs. sector fund difference? OP - are you at a more generalist fund?
Amazing that in LMM they are dividing total revenue by average number of paying customers !!
You're right.
But, do need to go down to the individual site level or based on geography.
Amazing right!!?
not the case at all firms
Thanks for letting us know
This concept was covered in the second row of OP's comment but thank you for the insight, much appreciated.
100% agree. This job is the coolest in the world (locked up capital paying ridiculous fees for zero risk adjusted value add while taking majority position on major companies) but the people, culture, and inane analyses make it unbearable. Anyone with a few months into to job quickly sees through it. The question becomes do you have enough stamina to suck dick until you are partner and you can abuse your lessers, or you cut your losses early and move on to something else.
it's just a job. sooner or later you realize every job (or at least 99% of jobs) is senseless/stupid/meaningless/maybe even harmful to society in some ways and pay less, with more inane coworkers and office politics still exists. i approach this job with the mindset that i'm just here to make money (to fund my lifestyle/retirement) and i'm willing to put up with some shit for this level of comp. when and if i change my mind because of internal or external reasons, i might change a job/career, but also i try not to sweat it/use my energy to hate on this job while i'm at it, because it's simply not worth the energy.
This. The sooner you realize this is just like any other job, we just get compensated better than most, the more at peace you become. All of that “Masters of the Universe” content you jerked off to in undergrad while sending out 50 cold emails per day to coffee chat is not real.
So ur basically waiting to die…
Jk I do the same thing.
Medicine and engineering are the only non stupid jobs imo
Most people acknowledge the bs and shut up once they start getting carry. Hang in there buddy.
Ah yes VC where you flip a coin on the conviction of the founder and throw a dart at the board to see if this will be one of the 80% of your investments that fail
Difference is that most VCs understand the industry falls within a power law
...
Wonder when those PE business will start exiting their super valuable assets...
PE returns benefit from a lot of BS let's be honest:
Not having to mark-to-market
Selling assets to their friends at other PE firms at unreasonable valuations
Literally not selling assets but keeping their marks at elevated valuations that they won't actually end up trading at (have you seen the massive overhang that exists now in the market?)
Selling an asset to another fund that the PE firm owns just so they can realize returns for their LPs and not have to admit that the market didn't want to buy their shitty portco
A 10+ year ZIRP environment where they can bully private credit firms into attractive cov-lite arrangements
OP here - as others said, tell me how much of those returns is just levered beta fueled by a decade of ZIRP. And to others’ points, 2020-2022 vintages across the street are not looking rosy (to put it lightly). I cover tech, and remember during this period when i was in banking seeing how much sponsors were paying for mediocre software assets and being unable to wrap my head around it. Can do all these little elementary math exercises to do a bottoms up ARR build by geography by segment to forecast a 30% revenue CAGR to justify the entry, but this is just self hypnosis at that point - not actual “data informed analysis”. Maybe price discipline is not IQ but more so EQ/“thinking independently”, but lot of principals/partners should be on the cutting block IMO based off some of their recent investments. And im sure this sentiment rings true across most other funds people here work at. Can use continuation funds and extend holds to 7-8 years rather than 5-6, but gotta face the music eventually and really think we’ll see whose been swimming naked over the next few years here. As i mentioned in original post, there are certainly funds with true edge but to say that the PE industry as a whole is differentiated in its analytical rigor or intellectual capability is comical.
What are those returns on a risk-adjusted basis?
What are those returns on a beta-adjusted basis?
To be fair, if you apply 50% leverage to the small cap public markets index returns (ie approx size of companies that PE invests in), it would match / exceed historical PE returns. This indicates historical PE ‘alpha’ really is closer to levered beta... and this is coming from a guy who's been in and around PE for almost a decade.
Edit: That's PE on average - of course top quartile funds will do better than the average or median. Try your hardest to join one of those! Will give you the best training even if you only stay 2-3 years.
Yeah I’ve always found it hard to believe that the control premium or 100% ownership is all that great. It can be since they don’t have public company reporting pressure but then you just change it to a PE fund reporting pressure. Given that most PE are generalist buyouts it’s hard to imagine they bring any expertise in that the company can’t already figure out and do themselves. Broadly seems like an expensive levered small cap equity strategy.
you right, OP meant 2.5x MoM
I may not be as bearish at the OP, but in my view, PE was a huge beneficiary of the migration from (relatively) high rates to low rates. While it can be said that so were stocks, bonds, etc., the exit multiple arbitrage really helped many funds/firms during a couple of decades when competition was modest. Now, as PE becomes highly saturated, it will be interesting to see how things unfold. There are a ton of well-known funds that paid premiums in 2021 that can't get out of their investments. Continuation Vehicles are just delaying the inevitable IMO.
Crazy differentiated take you got there, that PE was a beneficiary of low rates
Yeah. This is largely true of all PE/VC/HF roles. It is pretty rare to be in a position in the diligence stage where you actually have a real competitive advantage.
VC isn't really any better than PE in this regard. It just manifests itself differently. Especially with earlier stages of VC investing, there is no diligence you can really do. You are mainly just gaslighting yourself into thinking some founder is great, jumping on the bandwagon of a serial entrepreneur, or are riding market enthusiasm. To look at the extremes, (i) you either lie to yourself thinking SBF is god's gift to the world and are plowing money into obvious red flags, (ii) you are investing in James Clark's 5th startup because he was the entrepreneur behind Silicon Graphics, Netscape, and WebMD, or (iii) you are investing in artificial general intelligence companies because all the AGI market caps are hockey sticks right now.
HF's aren't really much better either. Most HFs do the same analysis using the same tools. For example, it is pretty rare to see the HF that actually goes out to see a sampling of the homes that make up the mortgage debt they are considering buying and talk with the actual homeowners. They all have access to the same expert networks, satellite data, etc. I do think the HF space in general is the most open to having actual competitive advantages in how they do diligence, but that's a low bar to clear and is much rarer than you might expect.
As you correctly point out, it isn't really the diligence and faux-precision that makes this difficult. It is the higher-level "qualitative work" that makes these roles difficult.
How do you view growth equity? Specifically funds that tend to target growing / profitable businesses?
The short answer is as a hybrid between VC and PE.
This all makes sense if you apply Matt Levine’s hedge fund manager framework. Your job is not to out perform, it is to run a fund. Raise capital, collect fee, deploy, repeat.
Investing is also inherently an individual sport. Great funds are created by individuals (see Great Man Theory). There’s only one Buffett. All the analysis is to comfort LPs but sometimes having the right vibes is all you need - it’s all discretionary.
"Great funds are created by great individuals (see Great Man Theory). There's only one Buffett."
It is interesting that you are talking about great funds and your example is someone who hasn't beaten the relevant benchmark. When you build a benchmark using Buffett's investment criteria, there isn't alpha. That means the greatness of Buffett isn't because of some individual greatness of Buffett himself. This is especially the case since just about anyone can replicate his strategy. It isn't like convertible arbitrage in the Japanese market where having access to financial instruments like ASCOTs can really impact the risk-adjusted returns.
At best, he should only be given credit for being able to attract the money that enables him to use the strategy. And is that really greatness as an investor?
Ignore my title. I smiled when I read this - so you’ve at last worked it out :) This is not just the case in PE but in all big corporate industries when doing long term financial forecasts. It’s all assumptions and BS which is why the cynicism appears in more experienced employees. Anyone who doesn’t want to recognize this is just lying to themselves/everyone else. But hey - the job pays/paid for your lifestyle!
If it’s a long term financial forecast, how can it not be based on assumptions? That’s exactly what makes it a forecast. Key differentiation is quality of the assumptions.
First, that's part of the point. If you are doing forecasts of anything more than ~5 years, unless you have functionally everything on such long-term contracts, you might as well get out the dart board.
Second, there are better approaches to forecasting. Like there are more theoretically sound ways to forecast than the Excel-based "qty times sales price" way most corporate forecasting is done. The problem is that the best way to do this is far from being commercially viable at this point.
If it's so easy / elementary why do the vast majority of analysts and associates suck
I strongly believe this is done either consciously or subconsciously to justify the extremely high fees. Reality is, the projections are virtually impossible and getting so granular adds no value. By and large businesses are going to work or they aren't and its not due to extremely granular projections. This isn't to say you dont need to understand the business and sector, etc. but the precision is just bs waste of time.
edit: I'll add this goes beyond these bs model. Any investor presentation or CIM is like 50% regurgitation and fluff. Like the bank is just so insecure of having a 5 page CIM on an extremely simple business model bc who would pay $1bn for business with a 5 page CIM. Translates to IC docs too. Lots of areas in our industry that are busy work driven as a matter of self justification.
"Government software business trading at 30x" - Ahh I love how basically Tyler in the US and Civica in EMEA have absolutely wrecked valuation expectations for even the worst software assets....
Civica is a piece of shit though...
You’ve focused too much on what’s meaningless at the job, instead of what’s important to make it to the top.
It’s true that a lot of the grunt work is just for show - but this is no different than many other jobs. There is an element of sales and marketing in any businesses. That doesn’t mean the job has no other skills. Even NBA players need good managers and be marketable to get shoe deals.
Many fund managers have grown & become pattern recognition machines, such that they can make high quality decisions by looking at a few key drivers (as you mocked). That’s the part that interest me anyway.
Sorry but did you read the post? It’s not that I’ve “focused too much on what’s meaningless” - my whole point is that a significant portion of associates’ jobs are exactly this meaningless analysis/work, explicitly requested by VPs/Principals/Partners.
Also why i said important aspects of the job are more qualitative (quickly building conviction on an asset, understanding what ACTUALLY matters for the business, and then deploying billions of dollars is not easy mentally) and why i believe the Principal/partner job is actually quite difficult.
Sounds about right. I hear similar stories from others in the business, but I have a feeling this is reflected in pretty much every other sector.
Just commenting here even if unrelated.
Does anyone know why I am not able to star my own discussion anymore? I’m new to WSO, have started a discussion but now an error pops out when I try to do it.
What am I missing?
I love this thread. I am certain there's a lot to learn about PE from OP and the respondents, and I'd bet of the analysis PE funds do could be massively improved. Look forward to chopping it up.
I come at this industry from the opposite side of the world - from China state-owned-asset buyouts and and growth capital.
This means we spent an average of 6 months (call it a range of 3-6 months with most being 6 months) getting to know each target company.
We would do deep DD on each target, and modeling was the least of our concerns. We were looking for fraud, embezzlement, entirely unreliable company financial data, etc.
That would be super interesting to hear more about. What were some of the red flags y’all would look for? Were you able to trust the given financials a lot? Or was it more about independent verification?
Spot on OP. So many PE funds are just expensive levered beta plays on private markets. After a decade and a half of ZIRP, much of PE has become commoditized. I am of the view that with developments in the secondary market being what they are, PE is going to become even more commoditized and consolidated in the next few decades.
Add in PE being crammed into semi-liquid vehicles for HNW individuals (and honestly not HNW individuals given minimums are tiny and most are accredited investor) and it's all going to be R2000/micro cap like returns with "no vol" as the marketing people say. From the allocator side I think this is a potential canary in the coal mine as illiquid assets in a semi-liquid wrapper never works long term.
Very good point. I think the big push to pump AUM further with semi-liquid vehicles and retail money as well as captive insurance co’s is telling. People on this board have slobbered over getting into MFPE since time immemorial but I think these mega cap public PE plays have grown so huge that their alpha has eroded and looks like it is being replaced by the 2% of 2 / 20. Not exactly something I’d be excited about.
No one is going to make a decision worth millions or billions without some kind of basis. Many decisions are based on feelings and bias and some of them pan out, but none of them can be made without support. Sure it’s dumb but hey at least you can get paid and learn something. If that’s not good enough for you then start your own business.
I hear only problems without solutions
no solutions here i dont think....
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