The success of the Blackstone-led consortium’s bid for Thomson Reuters Corp, along with the ongoing joint Arconic bid, have gotten people talking about a potential return to the pre-crisis era of club deals and collaborations.
Reuters’ price tag of $20 billion, making it the largest leveraged buyout since the crash, suggests an obvious reason why – inflated share prices are simply putting many good opportunities beyond the reasonable reach of even the largest firms. Combine with this the paucity of yield elsewhere and the abundance of cheap credit, and the idea of teaming up for private deals suddenly looks very attractive. The boom-levels build up of dry powder can only go on so long and collaboration provides an obvious outlet.
That this is only starting to happen now amid such favorable economic circumstances is testament to the mixed reputation club deals acquired in the years since their golden age. While firms and investors are well aware of the theoretical financial risk-spreading benefits involved, a number of high profile and messy bankruptcies, including the recent Toys R Us, have created a tainted association, a perception that collaborations are more likely to result in financial failure. In light of this, many feel that the challenges and risks from a governance perspective simply aren’t worth it.
Nonetheless a recent research note from Pitchbook suggests that this reputation is largely unfair, at least from the bankruptcy point of view. Collaborations in general are far less likely to go under than their sole-sponsor brethren, to the tune of 50pc.
This doesn’t quite mean firms and investors, disabused of this wrongheaded notion, should just steam ahead. As the evidence shows the commercial side of club deals has never really been the issue. What the worst examples do show (along with many others that experienced problems without going bankrupt) is that the governance and logistics of collaboration pose real and unique challenges that, handled badly, can cause disastrous fallout.
As Blackstone’s own CIO said earlier this year, “governance is very difficult when you have six sponsors”. Many of the high profile fallouts can be traced back not so much to financial fundamentals, but to a lack of communication and control, with peers often falling out and some unfortunate cases of recriminatory lawsuits. Private equity firms and their investors are very used to doing things their own way, with sole control. Working together immediately adds a layer of complexity and decision-making that most will be unfamiliar with.
Being on the same page from the start is critical: different parties are likely to have different aims, interests and expectations and this needs to be as transparent as possible. There will be a lack of standard structures to overcome, and time horizons are likely to vary (the long-term nature of private equity investments in general are unlike the timeframes some new investors will be used to).
Many operational questions also arise – who will be responsible for what, where will the team be? Who will do the reporting? Not everything will be obvious – for instance if investors have different sets of tax implications, how will this be handled? Expectation management becomes that much more important and difficult in any group collaboration, especially in cases where the investment hits stumbling blocks.
The concern is these particular operational and governance challenges are far bigger and complex now than they were during the previous era of club deals (and they caused enough problems then), back when private equity was still a relatively informal niche in the financial landscape. Current high share prices aside, there are some deeper structural forces at play that are likely to drive an increase in club deals going forward. More and more institutions with little to no prior experience with the asset class, from the big pension funds down to the new wave of family offices, are looking to increase allocations. Combine this with skepticism over traditional fund fee structures and performance, and a growing desire to “cut out the middle man,” and it seems inevitable that we will see more collaborations of various types going forward.
But this also means more diverse aims and interests, among less experienced participants, making the already-thorny challenge of expectation management even trickier. To compound the challenge further, increased regulation alongside the desire for transparency on the part of investors has significantly increased the reporting burden. Investors now both want and need granular and regular information on their investments, tailored to their own needs and profiles. Club deals, by their very nature, multiply this challenge. The ability to provide timely and relevant information is key to expectation management, which is that much more crucial in a group venture.
All of these problems are quite solvable, and for those firms that can solve them collaborations can work very well indeed. But the problems require significant thought, planning and – especially on the reporting side – adequate technological infrastructure. Any group collaboration that relies on ‘old style’ private equity communication such as the occasional PDF is asking for trouble in the modern environment, especially where non-traditional players are involved.
This is less of an issue for the big fund houses like Blackstone, which have adapted well to the digital era and have their own in-house software designed specifically for tracking private equity investments. But investors are far less likely to have these tools, and building them in-house for the purposes of individual collaborations would be commercially prohibitive and counterproductive time-wise.
Service-based third-party investor portals may well come into their own here, being far cheaper and also particularly suited to the club deal world in so far as they are designed for easy tailoring across users, and can readily be amalgamated with a parties’ other investments for the bigger picture perspective. For those running the club deal on the operational side, it also makes the critical job of expectation management that much simpler. In fact, outsourcing some of the operational functions of the deal in general to third parties, such as administrators and platform-providers, rather than having one of the involved parties run the show, can be a good basis for ensuring good governance and relations. Having an impartial third party as an operational partner can provide confidence, especially during difficult periods when parties’ interests are at stake.
A return to club deals could well be here. Given the long-term trajectory of the industry this was possibly inevitable. And there’s no reason why this type of investment shouldn’t be able to flourish. But only if firms go in with eyes open to the nature, scale and the challenges involved. Unless governance lessons are learned, and unless participants make full use of the tools at their disposal to ensure operational excellence, the grim headlines could also make a comeback.