AVCJ Awards 2016: Firm of the Year & Fundraising of the Year - Mid Cap: Quadrant Private Equity

Less than four months after closing its eighth fund at A$980 million ($754 million), Quadrant Private Equity has made 10 investments and committed approximately 40% of the corpus. Speed has become a characteristic readily applied to the Australia and New Zealand-focused GP - the most recent fund, like the one before it, took six weeks to close, while the gap between the two fundraises is only about two-and-a-half years - but the strategy has been consistent across multiple vintages.

"Our approach has not significantly changed for the last five funds, in that we are looking for companies with strong brands and market positions with superior growth opportunities and good management teams. Given our mid-market focus inevitably a large number of opportunities are private companies, many of them family businesses with succession issues," says Chris Hadley, Quadrant's executive chairman.

Platform plays

he IPO market will remain viable for assets of certain scale with good growth prospects. Whilst valuations change with market conditions and the timing of exit windows may challenge, the great thing is we can choose when to exit and IPO is only one avenue - Chris Hadley

It is also worth noting that six of those 10 investments fall under two newly-created platforms. They will occupy two slots in the typical seven-deal Quadrant fund, once again showing an appetite for bolt-on acquisitions and industry consolidation common to Australia's middle market. In both cases, there is an emphasis on partnership, with the previous owners remaining involved in the business.

The first deal was announced days after the fund closed in August, with an agreement to acquire Ardent Leisure's Goodlife Health Clubs business for A$260 million. With 76 locations and 200,000 members, Goodlife is the second-largest player in Australia's fitness club industry - which generates A$1.3 billion in revenue a year - and one of only three with a double-digit market share. The following month, Quadrant agreed to buy the market leader; Fitness First has 65 outlets and 240,000 members.

With the addition of low-cost gym operator Jetts Fitness as well, the private equity firm can claim to have created a truly national player. The fitness and lifestyle group - in which Oaktree Capital, the previous owner of Fitness First, will hold a minority stake - will serve 650,000 members across 224 directly-owned and 188 franchised outlets, generating annual revenue in excess of A$400 million.

Quadrant is pursuing much the same agenda in the tourism space. Also in September, an agreement was struck to buy Great Southern Rail (GSR), operator of three luxury transcontinental passenger services: The Ghan between Adelaide and Darwin; the Indian Pacific between Sydney and Perth; and the Overland between Melbourne and Adelaide (Once again, the vendor, Allegro Funds, will retain a meaningful minority interest in the business).

The tourism platform was subsequently bolstered with the purchase of Rottnest Express, a Perth-based ferry and tour service, and Cruise Whitsundays, a North Queensland operator known for its cruises to the Whitsunday Islands and trips to the Great Barrier Reef. The investment thesis is based on growing demand for higher-end, experience-based travel; customers of GSR make stops along the way for gold mines, ghost towns, and camel-riding, while Rottnest offers snorkeling, skydiving and whale watching.

"The plan is to have a single platform and do cross-selling," says Marcus Darville, a managing partner at Quadrant. "If we span a lot of the country with iconic experiences then we can pull together itineraries for people. You have 10 days in Australia and we can take you to these amazing places - some of which are owned by us."

Traditionally, these consolidation strategies bring a standardization and economies of scale to industries where this is lacking. Centralized procurement that brings down costs, the ability to execute capital expenditure programs, wider-reaching marketing and product development efforts, and relieving management strain on service-oriented leadership teams by bringing them into a big tent are all seen as advantages.

Where the fitness and tourism platforms - and a restaurant business created before the launch of Fund VIII but still being added to - arguably differ from previous roll-up efforts is that they focus on consumer rather than business services. Darville believes this indirectly reflects the rebalancing of Australia's economy in response to the commodities downturn. Quadrant's investments are driven by a consensus view on a particular sector set of assets but macroeconomic factors play a role. For example, the decline in the Australian dollar has encouraged inbound tourism.

Overdependence on consumer demand, and discretionary spending in particular, poses its own risks as evidenced by a number of failed private equity investments (none of them by Quadrant) in Australian retail. But Hadley plays down this concern, noting that the timing of investments made so far is a function of opportunity and the portfolio as a whole should end up reasonably balanced. He sees no real change in industry focus across the 63 portfolio companies the GP has backed across all its funds.

"The fund overall is likely to be pretty defensive in its sector focus," echoes Darville. "It is true that consumer is potentially more volatile than healthcare but we don't see ourselves targeting highly discretionary areas. Even on the restaurant side, the bulk of that platform is casual dining and there is a secular trend towards this globally. There is also a lot of organic growth in all of these businesses, gyms, tourism and restaurants, and that gives you a cushion."

The open question is how big these platforms could feasibly become and what impact this has on exit options. The tourism business has gone from zero to A$200 million in enterprise value within three months and is already larger than the leading listed company in the space. At the same time, these industries are deep and there are plenty of privately-owned companies whose founders might be willing to sell.

Exit options

All three of the consumer-oriented platforms are seen as potential IPO candidates. According to AVCJ Research, half of the private equity firm's last 10 exits have come via the public markets, not including subsequent sell downs. The earliest of these was Virtus Health in June 2013, which helped reignite investor appetite for PE-backed IPOs following a period of relative inactivity, leading to record levels of liquidity over the ensuing 24 months. However, demand has since tapered off, with only six offerings featuring PE sponsors this year, compared to 15 last year and 23 the year before that.

"I do not see massive cyclical risk here," says Hadley. "The IPO market will remain viable for assets of certain scale with good growth prospects. Whilst valuations change with market conditions and the timing of exit windows may challenge, the great thing is we can choose when to exit and IPO is only one avenue."

Indeed, Quadrant's last three exits have come via trade sale, with the most recent of particular note. The firm completed the sale of its 49.9% interest in Canberra Data Centers in September as Infratil and Commonwealth Superannuation Corp. bought 96% of the business for A$1.01 billion, including debt. It generated a 3.4x return and an IRR of more than 85% on a two-year-old investment. Darville notes that the average return on Quadrant's last seven deals is almost exactly 3x.

SIDEBAR: A very fast fundraise

Prospective new investors in funds raised by Quadrant Private Equity typically follow the firm for a couple of years before committing. When the time comes to conduct full due diligence, there is a preference to get as much of the work done in advance because the fundraising process itself has been so short in recent vintages. Approximately six weeks elapsed between Quadrant issuing the private placement memorandum for its eighth fund in early July 2016 and the vehicle's final close at A$980 million ($754 million). It was the same for the two previous funds.

"We tend to keep the terms simple and traditional, in line with what we've always done and in line with mainstream conventions. People know what they getting, which makes it smoother for everyone. Also, we tend to wait until we have completed the last investment in the previous fund - or are about to go with it - before launching the next fund, and then we never raise the maximum possible, we work out the fund size and stick to it. That's why it tends to be a quick process," says Marcus Darville, a managing partner with the firm.

As it turned out, there was only space for a handful of new LPs in Fund VIII. The vehicle was substantially oversubscribed and existing backers accounted for the bulk of the corpus. They include sovereign wealth funds, superannuation and pension funds, fund-of-funds, and government entities. This is the third Quadrant vehicle that has been open to international LPs. Fund VI was two thirds domestic and one third international; Fund VII and Fund VIII were more or less a 50-50 split.

"Our primary goal is to have a group of sophisticated LPs who display a consistent approach to private equity investing, understand our investment focus, rate the GP management team, and wish to invest with us over multiple funds. In addition there is a desire to have a balance of types of LP which naturally also includes diversity of geography. Logically LPs based overseas take some confidence when a GP has the support of a number of respected domestic LPs," says Chris Hadley, Quadrant's executive chairman.

Staying disciplined on fund size in the face of strong interest from prospective investors is also a priority. While increasing the hard cap means more fees, the risk is that it also necessitates a change in strategy that takes the GP out of its comfort zone and ultimately undermines performance. Hadley does not expect to see an uptick in competition from other private equity firms in the middle market, nor does he expect Quadrant to evolve beyond its current sweet spot of transactions with enterprise valuations of A$200-500 million.

"If the fund achieves timely deployment, executes the investment case and a subsequent realization, then a velocity of capital is achieved. This should more than compensate for the economics of any commitments forgone," he adds.

The firm has achieved that velocity, and if anything it is gradually increasing. Fund VI closed at A$750 million in December 2010 and Quadrant returned to market approximately three years later. The gap between Fund VII, which closed at A$850 million, and its successor was two-and-a-half years - suggesting a far swifter pace of deployment than the loose industry standard of five years. Fund VIII is already 40% committed, although Darville notes that the timing of deals can be unpredictable. For example, he spent 18 months working on the final investment in Fund VII.

"The trade off is we fundraise more frequently than many firms but our funds are generally smaller, and that means we can do smaller investments and secure more exclusive deals," he adds. "We could raise a larger fund, but that would have an impact on the number and nature of our investments. We don't want to be waiting on the next auction process or chasing public-to-private deals."

From an LP perspective, rapid deployment means less of a fee drag. The j-curve is shortened because less time is spent paying a 2% annual management fee on money that has yet to be put to work. At the same time, some investors are wary of these situations, asking whether a GP committing capital at such a pace is really targeting the best deals and expressing concerns about vintage diversification.

"I've not had that comment from any LP, although we are very aware of not buying too many assets at the top of a cycle and therefore reducing the fund returns," says Hadley. "Most of our LPs are very large and can easily manage their own vintage diversification. As a discipline we focus on getting cash back to investors early in the life of a fund so that they only have a limited amount of capital in the ground with us."

Pictured: Chris Hadley of Quadrant Private Equity

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Australasia
• Fundraising
• Buyouts
• GPs
• Trade sale
• Australia
• Quadrant Private Equity
• AVCJ Awards