Asia Summit—Investment Outlook from Global Industry Titans

September 23, 2016

Big Numbers, High Prices, and Optimism on China

The private-equity business continues to hold great potential as a source of rich long-term returns, but current market conditions are flashing warning lights, a panel told attendees at the Milken Institute Asia Summit in Singapore.

"We're living today in a very, very high-priced environment" for companies and other real assets, said Leon Black, chairman and CEO of Apollo Global Management, speaking at a session titled "Investment Outlook from Global Titans." Those high asset valuations are likely to translate into weaker returns over time for buyers who pay up in this market, he said.

Panel moderator Michael Milken, the institute's chairman, sought ideas from the panel on the best long-run opportunities for the PE industry, which has traditionally focused on buying businesses with borrowed money, improving their management and growth prospects, and eventually selling them or taking them public at a profit.

Black said that the average buyout price today in the United States and Europe is about 10.5 times a target company's earnings before interest, taxes, depreciation, and amortization (EBITDA)—"an all-time high." Apollo, however, has stuck with its value discipline and kept the average multiple under six times EBITDA on its recent deals, Black said.

titans panel

Leon Black, chairman, CEO and director of Apollo Global Management

Even so, he said the fastest-growing part of Apollo's $186-billion-asset business isn't private equity, but rather its unit that lends money to below-investment-grade companies. Those businesses make up the vast majority of companies, and Black said the opportunities to lend to them have expanded because many commercial banks have become more risk-averse since the 2008 financial crisis.

Lei Zhang, founder, chairman and CEO of Hillhouse Capital Management Group, said China remains fertile ground for private-equity firms in the long run, even though the nation's economic growth has slowed in recent years. "What is fascinating about China is the scale and the opportunity when you have a country going through what I call the triple combination: urbanization, industrialization, and the Information Age, all happening at the same time," Zhang said. "It's like having [Henry] Ford on cars, Larry Page on Google, and J.P. Morgan the financier all in the street."

But there also is an irony in China's position as a leading global manufacturer and exporter. For Chinese consumers themselves, Zhang said, "there is a lack of supply of high-quality products" to buy. His firm is trying to help fix "the big mismatch between the supply side and the demand side" of Chinese consumer goods. 

For example, Zhang has invested in China's largest natural pet food maker, which targets upscale Chinese consumers just as U.S. natural pet food companies have gone after upscale American pet owners.

David Bonderman, chairman and founding partner of private-equity firm TPG, also expressed optimism about the future of PE in China. His company was one of the first big players to enter China, opening a Shanghai office in 1994. "We have been generally bullish on China," Bonderman said, adding that "the best-performing sector has been the tech sector, by far."

He also prefers to deal with Chinese banking regulators over their U.S. counterparts. "Our experiences have been that if we go to talk to Chinese banking authorities, they make a hell of a lot more sense than U.S. banking authorities," Bonderman said, stirring laughter in the audience. "They're better educated, and they went to better schools."

Apollo's Black, however, has stayed away from China. "We think [asset] prices are relatively high," he said. "We just haven't been able to figure out where our edge would be in China."

As a final thought, Milken offered up the idea that, in a "world that can't find a way to get a 5-to-6 percent rate of return," pension funds and other institutional investors could better meet their long-term obligations to beneficiaries by investing more capital with private equity funds—perhaps $1 trillion to $5 trillion more. (Data firm Prequin estimated private-equity assets under management worldwide at $2.4 trillion as of mid-2015.)

But that raised the question of whether the PE industry could still expect to earn annual returns of 20 percent or more if vast new stockpiles of capital were chasing attractive young companies.

"Can [the industry] handle another $5 trillion? Probably not," Bonderman said.

Black agreed, but said other opportunities in the alternative-investing realm still could provide big investors with relatively high returns, if they're willing to take the risk. He cited financing of energy projects, for example, and loans to financially stressed companies in Europe.

Ideas like those, Black said, "are where a lot more capital could be deployed today."

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