Hauser Private Equity’s Mark Hauser on Special Situation Funds and M&A Trends

The COVID-19 pandemic has created an influx of buying interest from investors around the globe. However, economic changes and dwindling opportunities have created unprecedented competition, causing a shift in recent trends.

Experts in the industry, including Mark Hauser, co-managing partner of Hauser Private Equity (HPE), have leveraged their years of experience to navigate these competitive times. HPE is a hybrid private equity fund manager that invests in private equity funds and directly in privately owned businesses. The firm’s four funds have invested more than $300 million in capital in privately owned businesses across a diverse set of industries nationwide.

Here are some trends that have emerged over the past twelve months:

Private Equity Firms Are Leveraging Favorable Debt Terms

The pandemic caused a quick change in interest rates, creating opportunities for private equity firms to leverage debt for specific projects. In fact, this year marked an all-time high in loan volume as investors sought dividend recapitalizations, buyouts, and refinance options.

As of October 2021, loan volume hit $509 billion, surpassing the 2017 high of $503 billion.  Contributing to this debt have been mergers and acquisitions driven by lower-rate transactions. Mark Hauser and other experts warn that if rising valuations and interest rates slow the merger and acquisition (M&A) velocity, many financial sponsors could be stuck with highly indebted portfolio companies with a low ability to cover their debt loads.

Investment Trusts Are Returning to Specialist Roots

Investment trusts have started focusing on specific technological innovations rather than running generalist equity portfolios. The Financial Times points out the following examples of trusts participating in this trend: “Among the 11 trusts to be launched this year, HydrogenOne Capital Growth [specializes] in hydrocarbon stocks to help promote opportunities in clean fuel, and Seraphim Space Investment Trust is designed to fund space entrepreneurship, while Cordiant Digital Infrastructure and Digital 9 Infrastructure are the first two investment trusts with dedicated exposure to the infrastructure of the digital economy.”

Data from the Association of Investment Companies reveals that access to private assets has offered investment trusts “more money in initial public offerings and secondary fundraisings this year than at any point in their 153-year history.” Financial expert Mark Hauser, alongside other leading experts, expects investment trusts to turn to the private sector to leverage the flexibility of its closed-end structure. However, this strategy comes at a potential price – concentrated portfolios present a more significant risk, while a diverse portfolio reduces massive loss.

Deals Have Been Driven by Tech and ESG

Many industries have faced economic losses during the pandemic. However, tech and environment, social, and governance (ESG) companies have proven to be anomalies.

Tech, which is behind every leading sector, accelerated significantly during the pandemic as companies started relying on cloud-based systems that can support a work-from-home model. Because some behaviors have changed forever, private equity firms have started seeking investments in companies that develop innovative technologies to meet today’s demands.

Similarly, ESG remains at the center of private equity attention. Although it predates the pandemic, ESG has increased in popularity due to the recent social justice movement. Firms are focusing on opportunities that offer measurable goals associated with social and environmental change, as well as ESG integration.

M&A Activity Is Driven by Private Equity

Recent reports reveal that private equity now “represents 30 percent of the M&A market, surpassing the prior peak of 25 percent in 2006.” During the first three quarters of 2021, private equity firms invested $868 billion.

Mark Hauser, whose firm has continued making acquisitions during the pandemic, supports the most recent analysis by Pete Witt, a lead private equity analyst at Ernst & Young. Witt concludes that three factors have driven the recent private equity M&A activity: a “cyclical” component, driven by a strong earnings season and persistent low-interest rates; an “idiosyncratic element of the pandemic” as business activities return to pre-pandemic levels; and a “secular component” that comes from regulators, particularly the Securities and Exchange Commission (SEC), which has been encouraging retail investors to enter private markets.

Private equity firms have been targeting specific sectors during this period of economic volatility, including technology, consumer, and healthcare, due to their strong resilience. Technology M&As have accounted for about 25% of deals by value and 30% of deals by volume over the past 12 months, while consumer and healthcare represent 12% and 10% of private equity deal value over the last year, respectively. 

Interest in these sectors has been attributed to long-term growth prospects as well as their association with ESG investing.

Hauser Private Equity has targeted acquisitions in the healthcare and consumer sectors, but its investments pre-date the pandemic, indicating the firm’s ability to invest ahead of the curve. HPE’s current healthcare ventures include direct investments in Beacon Orthopedics, Cincinnati Eye Institute, Doctor’s Best, Elite Body Sculpt, Injured Workers Pharmacy, Omni Eye Services, and Stat Health Management. Meanwhile, the firm’s direct investments in consumer goods include Argo Tea, Carson-Dellosa, Cherry, Corsair, Dennis Uniform, Igloo Products, Life Style Solutions, McCubbin Brands, Rack & Riddle, and Walker Edison.

Private Equity Is Accelerating Infrastructure Spending

President Biden recently signed a $1 billion infrastructure bill geared toward improving the deteriorating U.S. infrastructure. Private equity firms, which already invest heavily in construction and maintenance services, are expected to accelerate spending by targeting services that will be in high demand as the bill includes “programs that will improve the nation’s roads and bridges, repair more than 24,000 buses and 5,000 rail cars, and construct new electric-charging infrastructure.”

Additionally, according to experts such as Mark Hauser, firms are expected to benefit by offering financial capital to public capital, increasing total resources to support the various plan components. Private equity is expected to continue seeking opportunities in infrastructure, particularly given the “favorable, long-term macro tailwind.”

Private Equity Is “Underperforming”

Challenges in the current economy have caused private equity firms to report underperformance. However, experts like Hauser share the perspective that such reports fail to consider the effects of the pandemic.

Sacramento-based pension plan CalPERS (California Public Employee Retirement System) reports a net return of 43.8% for the fiscal year ending in June 2021. However, the fund also reports that it underperformed its benchmark by 1,730 basis points over one year, 56 basis points over three years, 209 basis points over five years, and 147 basis points over ten years.

However, the inconsistency in returns should come as no surprise since the pandemic has reduced portfolio diversification and created high costs for investments. Valuation adjustments need to be implemented to accommodate shifts as the economy’s current status has rarely experienced such a change. 

The global private equity industry is growing. Pent-up demand for deals was unleashed at the end of 2020, following a brief hiatus as the COVID-19 pandemic sent economies all over the world into lockdown. As we head toward 2022, there is little sign of this momentum letting up.

About Hauser Private Equity

Founded in 2008, Hauser Private Equity is a Cincinnati-based hybrid private equity fund management firm that focuses on direct co-investments in the lower-middle to middle-market range. Investing via partnerships with control buyout funds and selectively with managers of growth equity and special situation funds, the firm’s four funds have invested more than $300 million in capital in privately owned businesses nationally across a diverse set of industries.

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