Q&A: Pacific Equity Partners' Tony Duthie

Q: PEP's broad approach is buy underperforming market leaders. Do you see any reason to tweak this strategy in the coming cycle?

A: No, we won't tweak it. If anything we will focus more on that strategy because over the last 15 years these have been our best-performing assets. Research by Bain & Co. and others shows that 50% of market leaders underperform relative to what their achievable return on capital should be. That really provides for us the headroom to drive performance improvement.

Q: In the last 12 months you have completed carve-outs of Peters Ice Cream and SCA, and a take-private of cleaning and catering contractor Spotless. What developments do you see in where deal sourcing?

A: Carve-outs, either from domestic corporates or multinationals, have always been a consistent source of deal flow for us. This is often a function of leadership change in a company. What we have seen in Australia post-global financial crisis is the turnover of CEOs has increased and that typically leads to a change in strategy followed by divestments. In multinationals, a change in strategy at the center will lead to a business becoming non-core. Public-to-private deals are more cyclical. We managed to acquire Spotless at an attractive multiple - sub-7x EBITDA. As valuations and multiples go up, the bar over which we have to climb to do those deals gets higher, so we need more conviction around the value addition story. The third bucket is private companies. We are seeing a number of businesses come to market, and this is partly driven by succession changes as the post-war generation of founders reach the end of their working careers. However, it is hard to find genuinely underperforming market leaders in this segment because the owners tend to be entrepreneurs who optimize as much as possible. There isn't much low-hanging fruit.

Q: Taking Peters Ice Cream as an example, what will you do to improve performance?

A: It wasn't meeting their internal target returns so Nestle decided to divest. From a revenue perspective, there are opportunities they weren't able to take advantage of due Nestle's corporate policies, such as working more closely with retail partners to develop products. Also, the business was burdened by infrastructure and costs that were entirely appropriate for a global food enterprise but aren't really required for stand-alone ice cream business in Australia.So there are opportunities to simplify processes, systems and structures, and thereby reduce costs.

Q: Public market exits in Australia have been difficult for a couple of years. How has this affected PEP's approach?

A: Whenever we consider acquiring an asset, we spend a lot of time thinking about how we are going to sell it. IPOs are one of a number of exit options we consider, as well as selling to a strategic buyer or a secondary buyer. It's also worth noting that strategic and secondary buyers will typically pay a control premium for the asset while the public market demands an IPO discount.

Q: Numerous Australian firms are turning to the US markets for debt financing - and this reportedly includes PEP-owned cinema chain Hoyts...

A: We completed a refinancing of Hoyts in the US market and that was very successful - it was well received by investors and we were able to upsize the offer. It's the first time we have done something like that. What this has done is make the local banks compete more aggressively and allow us to do things like dividend recaps and improve the terms on which we are able to borrow. There are a number of companies in our portfolio where this is particularly relevant and we are taking advantage of the situation, although we are being cautious not to ramp up the leverage.

Q: What about the foreign exchange risk?

A: We can swap out the currency and interest rate risk. That is one thing that has really changed in the last 12 months, primarily thanks to the Nine Entertainment restructuring deal, which laid much of the groundwork. We can swap these packages back and still be very competitive with a domestic structure. In addition to that, we find that some of the terms outside of pricing - such as tenor, covenants, and use of the funds - are more favorable than what we would get domestically.

Q: An increasing number of LPs express an interest in co-investment. How is PEP responding to this?

A: Institutional investors are clearly becoming more sophisticated in their approach to co-investment, setting up teams and staffing them with high quality executives. We have recognized that, and in our new fund we have dropped the sidecar fund because that capability is old technology. Instead, we are going to establish a small group of sophisticated partners, understand their criteria and processes, and replace the non-discretionary co-invest with institutions capable of investing with us on a discretionary basis. We see that as market leading and it reflects the way our LPs are heading. It's not for everybody. Indeed, many LPs don't want to participate because they don't run those types of programs.

Q: Australia has a general election in the autumn. What does this mean for private equity?

A: Private equity is in good standing with both sides of politics and I think the Australian Private Equity and Venture Capital Association (AVCAL) has done a good job of maintaining relationships with the two sides. But any new government is going to be under pressure to reduce the budget deficit and that could be positive for private capital. A progressive government is going to think through incentives to increase private investment in the economy.

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• Topics
• Australasia
• Buyouts
• People
• Australia
• Pacific Equity Partners
• buyout