Q&A: Pacific Equity Partners’ Jake Haines

Q: What led to the launch of PEP Capital Solutions?

A: It came from reflecting on the pattern of deal flow we had been seeing over the last 25 years, which included a significant number of businesses where we formed a positive view of the company and management team but where shareholders ultimately didn’t want to sell equity. They didn’t want their governance dynamic to be upset, they didn’t want to be told when to sell, and they were so convinced of the upside that they were very protective of diluting the value of their equity. If we wanted to get capital into those situations and help them grow much like we would in a control equity situation, we needed another arrow in the quiver. A credit instrument solves for that while allowing us to leverage our private equity toolkit. With our credit strategy, we spend a lot of time thinking about the management team because that’s who we’re backing. It’s about making sure we are all on the same page about what we are trying to accomplish with the capital and our toolkit, so we can integrate ourselves into the execution. We want to make sure we have a finger on the pulse – with deeper engagement than a lot of traditional credit strategies – so we can course correct if necessary.

Q: When did you start investing?

A: We built an open-ended fund structure and initially raised enough money to do a couple of deals. The first investment was in March 2021. It was a services business – a good brand, but a bank was moving out of the sector, so there was a portion of refinancing and a small growth facility that we put in place. We got on with the management team and we knew we could bring to bear some of our toolkit.

Q: Why go for an open-ended fund structure?

A: It was a new product for investors, so we wanted to give them an opportunity to dip their toes and then follow their money into the structure. At the same time, while we had conviction in the opportunity, we weren’t sure about the cadence of deployment. Raising a big pool of money that sits there and creates deployment pressure didn’t feel like the right course of action for a growing strategy.

Q: What is the nature of the LP base?

A: It is a pretty even spread between family offices, high net worth individuals, and institutions. On the equity side, we are still heavily institutional, but we realised this product would appeal to a different part of the investor universe. While more individual investors are getting comfortable with traditional closed-end funds, it’s a long way from mass appeal. The credit strategy is a great way for those investors to get to know PEP. As we go into the next raisings for our equity funds, developing the family office and individual investor base will help us diversify and expand.

Q: How much capital has been put to work to date and how big do you want to become?

A: We have made AUD 700m in commitments and there is about AUD 500m in the current portfolio. It’s an evergreen fund, so we bring in capital monthly and investors can elect for redemptions on a quarterly basis to be satisfied through the return of capital from investments. Every time we get capital back from an investment, which should be regularly, some of it can be allocated for redemptions and the rest is reinvested. As the fund continues to scale, I think there will be 20 or so positions, with around AUD 1.5bn under management.

Q: What represents the sweet spot in terms of commitment size?

A: We didn’t want to create too much concentration risk in the portfolio, so we started at AUD 25m, and we are now doing AUD 75m-AUD 100m. I think AUD 50m-AUD 150m is the sweet spot. We can target established mid-market businesses that are too small for the global or direct credit programmes that usually want to deploy significantly these days.

Q: To what extent is domestic banks scaling back lending activity the main deal driver?

A: A lot of people point to that as a sudden catalyst; it’s been happening for a while, and it will continue for many more years which is a helpful structural tailwind. The biggest shift for the banks has been the pivot away from mid-market and lower mid-market lending. They aren’t shutting the door on existing clients, but when a company wants an advance or the expansion of a facility – anything that’s a bit different – they get a quick no. That is the backdrop we are pitching into. We want to work with groups where we know the capital is going to drive value and they have bought into the fact that having a partner along for the ride is going to be worthwhile. Ultimately, that is how we generate our premium.

Q: What tend to be their needs?

A: Every business reaches inflection points where they stop and ask, do I sell, invest, or do nothing? We are appealing to those that want to invest and ride to the next inflection point, which is often a potential liquidity event. In many cases, they don’t know what to do from an execution perspective, a tactics perspective, or in terms of capital. M&A is the classic example. Most companies haven’t done much of it, but when they reach a certain size, it becomes the next logical step. Other scenarios might include wanting to consolidate their store network, adding another line to a manufacturing facility, or undertaking a wholesale procurement and supply chain revamp. We have experienced all these and more through our control equity portfolio. We can say, ‘We’ve seen that, let us introduce you to someone who can help,’ or ‘We’ve done that, let us show you the playbook.’ A lot of it is about being able to understand the landscape and knowing what to do and who to talk to.

Q: How do you see the strategy evolving?

A: We see a huge opportunity in continuing to support mid-market corporates. We also see significant opportunity in supporting mid-market sponsors, especially folks who are targeting assets outside of where our buyout colleagues focus. They have historically been serviced by the big banks but haven’t had the full suite of institutional or private credit offerings in the same capacity as larger sponsors. That is a really interesting next horizon for us. We have done a couple of sponsor deals and are keen to do more. In addition to acquisition financing, we see ourselves as particularly useful in the current environment with portfolio recapitalisations and refinancings, and we are interested in doing fund-level finance. This is a highly differentiated value proposition for the mid-market, and we would like to build scale within this vertical. Maybe at some point, it would make sense to build that into a separate strategy. In all cases, it is important that we have skin in the game and borrowers can trust in the relationship. A lot of the discussions we have are about what happens if things go wrong and how we will respond. People take comfort from the fact that we are local investors with a 25-year track record in this market and we are trying to build a sustainable business. We have a vested interest in being constructive and pragmatic.

Q: What is the approach to deal structure, from an upside and a downside perspective?

A: There is usually a cash component and sometimes an accruing PIK interest component. We’ve done deals where the PIK interest component converts into equity, but it’s not the main objective of the strategy. We are a performing, cash-yielding credit strategy with an emphasis on downside protection. In terms of structural protections, we think that if you wait for a covenant to be tripped and rely on enforcement, a lot of value will be destroyed. Our approach is to understand what a business is trying to do and build the capital around that strategy. If things start moving outside of those strategic and financial guardrails, we should have some leverage structurally that allows us to talk to the borrower and reach an interim solution whereby a bit of cash flow is diverted to de-risking us and paying us down. If the business continues veering towards a covenant breach, we are better positioned for that: there’s been a discussion, some amortisation has been pushed through, and a plan has been put in place. Our position should be easier to deal with because it’s smaller and we are in there helping the business work towards an outcome.

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• Topics
• Australasia
• Credit/Special Situations
• Credit
• GPs
• Australia
• Pacific Equity Partners
• private debt
• Structured finance