Tully Friedman: PE hitting market peak, trouble on horizon

Tully Friedman has seen this movie before.

“I’ve operated through four or five of these cycles, and I don’t think it’s even a close call. We’re at a [market] peak,” said Friedman, who was accepting a lifetime achievement award at Buyouts PartnerConnect West event in Half Moon Bay.

“You hear this time’s different — it isn’t,” he said. “I think it’ll end in tears but it’s gone on much longer than I thought it would.”

A combination of larger fund sizes and the availability of cheap debt has driven up the cost of new portfolio companies, pushing prices on mediocre assets into double-digit multiples on their annual earnings before interest, taxes, debt and amortization (EBITDA). Companies that should be selling for 7x-8x EBITDA wind up trading at 10x to 12x, he said.

Friedman, a co-founder of Hellman & Friedman and later FFL Partners, said the high-price environment for new mid-market buyouts made private equity “not as good a business, not as good an investment.”

“[Private equity’s] still pretty good, still producing great returns, but always cyclical and vintage matters,” he said.

More specialization

Even so, general partners are feeling pressure from their fund investors to deploy capital. Many LPs are finding themselves beneath their target allocations to private equity, thanks in no small part to rising equity markets, which contributed to a surge in US private equity fundraising. Earlier this year, Buyouts reported US private equity firms are poised to raise any year since the financial crisis.

“Our investors are less and less tolerant of us sitting things out,” he said. As a result, “we’ve evolved from pretty much a generalist firm to one that’s more and more concentrated in more and more granular subsets of various sectors.”

FFL is increasingly focused on “highly granular and discrete sub-sectors of industries,” Friedman said, citing recent investments in optical retail businesses as an example. The firm acquired a pair of optical platforms and has since been doing roll-up deals for smaller optician practices and eyeglass retailers.

“It’s a terrific business, because you’re getting 70 percent to 80 percent gross margin on [eye] frames and [lens] coatings. We think we’re still in plastic, you think you’re buying a medical device,” Friedman said. “We’ve deployed $300 million to $400 million into these businesses, and they’re doing quite well.”

FFL Partners IV, a $2 billion vehicle Friedman said will likely be his last, is roughly 60 percent deployed with three years to go on its investment period. He’ll continue to advise the FFL Partners team when the firm raises its next fund.

“I thought it’d be pretty hubristic to be a full-time investor with this fund three years from now,” he said, echoing comments he made about FFL’s succession plan in 2014.

Fund IV was netting a 2.97 percent internal rate of return as of March 31, according to Washington State Investment Board documents.

Action Item: For more information on FFL Partners, visit www.fflpartners.com

Buyouts Executive Editor David Toll interviews Tully Friedman, co-founder of Hellman & Friedman and FFL Partners. Photo by Sam Sutton.