The Leveraged Buyout Industry Is Starting to Eat Itself

(Bloomberg Opinion) -- A giant of U.S. private equity is taking a stake in a smaller European rival. It's easy to see what's in the deal for London-based BC Partners; for Blackstone Group LP, the investment logic requires more imagination.

BC, which has $27 billion under management, was carved out of Barings Bank following the lender's collapse in 1995. The firm made its name by shunning technology companies before the dot com bubble burst and focusing instead on unloved industries – a strategy that helped the funds it raised in 1997 and 2000 to make an impressive 24% internal rate of return.

In recent years, though, performance has been deteriorating. Returns from its 2011 vehicle – which is still to be fully liquidated – are in the third quartile of funds for which Bloomberg has performance figures. The latest fund, which is still investing, is down 11% so far.

BC has suffered from some troubled investments: British real estate agents Foxtons, satellite group Intelsat SA, U.K. retailer Phones4U and U.S. retailer PetSmart Inc. In private equity, you can have one dud – but a handful gets noticed.

In 2017, Raymond Svider tried to revamp BC's management structure, installing himself as sole head. That overhaul will take time to feed into improved investment returns. And the stubborn fact of life is that past performance is a key driver of fundraising success: The firm took 18 months to raise its most recent 7 billion-euro ($7.8 billion) fund.

For BC, raising the next fund is going to be challenging at a time when the industry as a whole seems to be awash with cash.

Enter Blackstone. It may invest about 500 million euros in BC for a 10% to 15% stake, according to Bloomberg News.

The benefits to BC are plain to see. Above all, it gets an important vote of confidence from an industry leader. This is an ingenious way to get a halo. The financial proceeds can be used to bolster its core private equity business and expand its newer real-estate and credit operations. Blackstone may be able to advise BC on precisely what kind of firm it should be, in particular whether it should narrow its focus from the seven industries it currently targets.

For Blackstone? It invests in alternative asset managers as an asset class in their own right through its Strategic Capital Group, so this isn't a new departure. It probably has more money than opportunities. There is some logic to investing in familiar territory.

What's more, there's a hint of opportunism here. The worst may already be behind BC. It has scored some decent exits lately, with the sale of financial data provider Acuris and animal health unit Antelliq. And it's not often that the chance comes along to take a meaningful stake in a firm like this.

Europe's private equity shops, still closely-held partnerships, are typically smaller than their U.S. peers, something that is making it increasingly difficult for them to compete in a world where buyouts are getting ever bigger. Don't expect BC to be the last in the region to seek an ally.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.