Cyril Demaria is author of "Private Equity Fund Investments" (Palgrave Macmillan) and of the bestseller "Introduction to Private Equity" (Wiley) translated into French, Spanish, Portuguese and Mandarin. He is also an affiliate professor at various leading global business schools and has been head of private markets research at the chief investment office of a large Swiss bank in Zurich. He says that Switzerland is an active private equity market dominated by small to midsize buyout out deals, but one where activity is difficult to capture.
Leaders League. How is the performance of Private Equity markets in Switzerland compared to other European nations that have been touted as private equity hotbeds in terms of market size and growth?
Cyril Demaria. Switzerland is an active market, but a rather small one. The market segments dealing with startups and with transfer of ownership of small and midsize companies (for example with succession issues) are relatively active.
Switzerland is also an unusual market because a high proportion of actors are rather wealthy, have the means to do deals by themselves, and often have the technical know-how of doing that. So a significant portion of deals are under the radar and not documented. As such, if you look at the underlying weight of deals in Switzerland, it doesn’t reflect the full potential and activity.
If we go one level above, based on statistics from the Swiss Private Equity and Corporate Finance Association (SECA), fund level activity is at an all-time high and the Swiss market has been following the evolution of major European and American markets.
At the level of fund of funds, activity had started to plateau. This is because fund of funds are expensive and many investors think that they could replicate these instruments by themselves. However, interestingly enough, some of the family offices and wealthy individuals, who have been trying to bypass this kind of offer, are coming back to it. The reason being that global coverage of all the private equity strategies is extremely difficult to do by oneself and economies of scale are needed to justify doing this on your own – you need to have a large enough program to justify individuals working for you, otherwise you would just end up incurring more expenses. A mixed approach is sometimes more popular, with direct investment in some geographies, investment in select funds in some – as you know them well - and investment through fund of fund vehicles in other geographies that are not very familiar.
Leaders League. In which key cities is most Swiss private equity activity concentrated?
There is a big pool of innovation in Lausanne, thanks to the Polytechnic Institute of Lausanne (EPFL), and in Zurich, majorly due to the Technology Institute of Zurich (ETHZ) as well as the University of Zurich. There are quite a few other universities of applied sciences, but the ones mentioned are the major innovation centers. These are fundamental research outfits; hence innovation doesn’t always translate into startups.
There are some other regions, such as Basel and Geneva. These are more focused on bio-sciences because of headquarters of companies like Novartis, Roches, Merck, etc. This gives birth to spinoffs – startups emerging from large groups. In Zurich also, there is a mini cluster of biotech firms.
Leaders League. In which deal size category is there the most equity in Switzerland?
Switzerland has a culture of family owned businesses, with many being transferred from generation to generation and not necessarily resulting in buyout activity.
We know for sure that there is activity mostly in the mid-buyout segment. There is also activity within the small-buyout segment, but that is normally not reported. But we can safely assume that activity is mostly concentrated in the small to mid-buyout category and this trend is rather stable over time.
Every now and then, we have a mega-buyout. There was one recently in the telecom sector and prior to that there was one in the healthcare space. Typically, it is either an international player engaging in such a transaction, or a combination of international plus local players.
While there are many headquarters of large corporations in Switzerland, they are multibillion dollar enterprises and are not the usual buyout targets.
Leaders League. Is the appetite for private equity high among the ultra-high net-worth individuals (UHNWI) and family offices whose needs are catered to by Swiss private bankers?
Yes, UHNWIs are very interested in private equity investments and the reason is not just pure asset allocation, but more involvement with the target company given investment in a direct fashion. The good thing is that family offices and UHNWIs are ready to take different kind of risk and envision different kinds of investments, as well as be more patient to accept more illiquidity. However, there are no public statistics on how much capital is committed or deployed for private equity by this segment of investors.
Statistics are also not easy to capture as private equity is not necessarily pushed actively by private banks because it is a net outflow of money for them. They charge you a fee when you invest through them in bonds or stocks, but if you invest in private equity (such as direct investment in a startup) then it’s money they don’t manage or advise you on – hence it is not fee generating for them – unless they have an offering themselves, which is what they are currently developing. Private banks are currently testing different models such as pre-packaged club deals, co-investment opportunities, etc.
Going forward, such investors are likely to revert back to safe/liquid assets should a financial/economic crises happen. However, the sector will remain attractive for investors with a very longterm view who can afford to spare assets regardless of market and their life events.
Leaders League. Based on your experience as a researcher and author of various publications on private equity, do you feel that the principle of mean reversion holds true for buyout exit multiples and IRRs? And how are these metrics expected to evolve going forward?
The buyout market represents roughly 50% of total private equity activity, with US alone accounting for over half of the global activity. The first buyout was in 1964 in the US and the technique arrived in Europe sometime around financial deregulation during the 1980s. As such, it’s a fairly new market that is still evolving and we do not have a longterm, 100+ year history to give a fair idea of mean reversion across numerous business cycles. Another factor that creates a problem here is the shadow part of the market that is unreported.
Going forward, the IRR and multiple evolution depends on different market segments, as defined by deal size. According to the Pan-European Private Equity Association (Invest Europe), there are various deal categories. Mega buyout refers to deals over $1 billion of enterprise value, large buyout is $500 million to $1 billion, mid buyout is $250 - $500 million and small buyout is anything less than $250 million.
There were announcements by key market players over the last 12-18 months, cautioning limited partners of lower returns in the longterm. These players essentially focus on large and mega-buyouts, and the reasons for their announcement are threefold. First, there is a lot of capital available. Second, there is competition from strategic investors as well as from other funds focusing on the same investments. And third, the deal flow is starting to dry up as some of those investing directly plan to hold for 15-25 years.
The segment of small to mid-buyouts is relatively immune to the above phenomenon. Firstly, you cannot raise multi-billion dollar funds to do small to midsize deals – there is a limited number of deals you can do and monitor given the number of investment personnel you have. Secondly, the deal flow isn’t really affected by capital market dynamics because it’s more traditional family businesses going to the next stage. As a result, IRRs in this segment are not expected to go down as dramatically as in the large to mega-buyouts segment. Multiples are also under control because of relatively less competition and more risk already resulting in conservative pricing.
Affan Bin Mahmood