Think inside the box

Private equity can feel like something of a “black box” when you are fresh to the sector, given that the drivers of performance can be very different to those experienced by listed equity funds.

However, with the listed private equity sector offering investors the opportunity to diversify their portfolios with the addition of private equity exposure but without locking up their cash for an extended period, it is worth exploring these differences.

An ideal blend

One central example is M&A. While M&A activity can be a boost to listed equity investors, it also serves to reduce their markets – which are already shrinking due to falling listing numbers – and generally serves as a bonus to the core investment thesis.

For private equity investors, the story is very different. The potential for M&A can be a key aspect of the investment thesis when entering into a private equity transaction. This is because successful M&A can transform a business. An acquisition could build market share by adding new geographies, customer groups or products to a company’s operations. Further, the synergistic relationship between two newly-combined companies can lead to improvements to operational efficiency, resource allocation and processes, ultimately raising profitability.

M&A has always been a value added strategy for private equity managers, but in the current environment has become a key source of growth, with deal numbers rising over the last year. M&A transactions among private equity-owned companies generally fall into two camps: systematic (or roll-up) mergers and strategic acquisitions.

The first category, roll-up mergers, focuses on the acquisition of smaller companies operating in the same, often fragmented, industry, with a view to fully integrate these businesses to create a larger more diversified company. Following this process, and given that the acquisitions often take place at relatively lower valuations, the combined entity may be able to be sold at a higher valuation. Strategic acquisitions tend to be transformative larger acquisitions; merging two, often market leading, companies with all of the associated benefits of scale and end market diversification.

NB Private Equity Partners (NBPE) is one of the private equity investment trusts that has seen a high level of M&A in its portfolio recently. Indeed, of its 30 largest holdings, over 20 have participated in some form of M&A during the ownership of the investment.

Roll up, roll up

When it comes to roll-up mergers, an NBPE portfolio company that demonstrates the benefits of this approach is USI. It provides primarily mid-market US companies with consulting and brokerage services in property, casualty and employee benefits. NBPE co-invested with KKR when it acquired USI in 2017.

The market the company operates in is hugely fragmented, so it has used acquisitions to build scale, presence in new geographies and add product capabilities. For example, in 2020 it acquired Associate Benefits & Risk Consulting, in a carve out of the insurance brokerage of a large bank.  

Elsewhere, more recent portfolio holding Monroe has also successfully executed a complex acquisition strategy. When NBPE invested in it in 2021 alongside AEA Investors, the custom component and hardware manufacturer had already acquired 11 businesses.

Since NBPE’s investment, it has integrated a further 10 businesses into its ‘OneMonroe’ platform, companies which should help drive growth in earlier acquisitions by improving sales and marketing capabilities.

Tactical advantage

The other form of M&A activity discussed earlier, strategic or transformational M&A, does not take such a structured form and typically happens in isolation or alongside one or two other acquisitions. Nonetheless, it can be transformative, particularly in industries where adding complementary products or go-to-markets can fuel growth.

An example within the NBPE portfolio is Solenis, a manufacturer and distributor of specialty chemicals and solutions. NBPE co-invested when Platinum Equity acquired the business in 2021, with a view to merging it with the existing Platinum investment in Sigura. Following that merger, a further acquisition of Diversey, a provider of hygiene, infection prevention and cleaning solutions, completed the picture.

Solenis ended up with significantly more scale and a full suite of solutions for its clients. Opportunities like this often required further equity, and in the case of Solenis, NBPE made a follow-on investment, demonstrating the managers’ confidence in the value of the combined entity and re-emphasising the transformational potential of M&A strategically.

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