Private equity deals where the seller is also the buyer

0:00Thinking long-term about your investment career? Hear stories, advice, and lessons from seasoned leaders at Capital Group on the Capital Ideas Podcast. Subscribe and start listening today. Published by Capital Client Group, Inc.

0:17Good morning from the Financial Times. Today is Tuesday, April 28th, and this is your FT News Briefing. More and more countries are cutting energy taxes, and Beijing just broke up a massive artificial intelligence deal. Plus, private equity funds are using a tactic that's raising some eyebrows. We'll talk about what it means for investors. I'm Mark Filippino, and here's the news you need to start your day.

0:52The number of governments that have cut energy taxes has doubled over the past month. The total is now at 39, and about half of those countries are in Europe. That's according to an FT analysis of data from the International Energy Agency. This is a widespread attempt to curb the effect of high prices caused by the Iran war. The price of Brent crude was at$108 a barrel on Monday, and Goldman Sachs says that could reach$120 if the conflict drags on. But cutting taxes isn't an easy answer. It addresses the energy price shock in the short term, But as the International Monetary Fund points out, it'll also test public finances that are under stress.

1:32The fund warned this month that because many countries already have a lot of debt, they should take a cautious approach to fiscal policy.

1:46China is ordering Meta to unwind a major acquisition. Beijing is taking issue with the U.S. tech giant's purchase of the AI app Manus. It bought it earlier this year for$2 billion. Now, this is a big deal for two reasons. One, Beijing went beyond its borders to break up that deal. Manus was founded in China but moved to Singapore last year. And two, this is an unusually late-stage intervention for China. It all says a lot about the race for dominance in AI. I'm joined now by the FT's global tech correspondent, Tim Bradshaw. Hi, Tim. Hi, Mark. So why did China block the deal? The official reason that China gave on Monday was that it was a foreign investment in a Chinese company that presented national security risks, which is complicated because as far as Manus is concerned, they are officially based in Singapore these days.

2:39But it also comes at a time when there is great tension over AI and national security between Beijing and Washington in both directions. Washington is very keen that China does not get hold of the latest AI models from Silicon Valley companies and increasingly the chips that power them. And China is trying its best to nurture its own domestic competitors to that, of which Manus was one. Now, I kind of alluded to this earlier, Tim, but how big of a deal is this for Beijing? I think the significance for Beijing for this one is partly to do with AI and partly to do with Singapore. A number of big Chinese tech companies have tried to relocate their headquarters to Singapore, including Xi 'an, the big retailer.

3:26it's sometimes known as Singapore washing, where Chinese companies try to move out in such a way that makes them more available to foreign partnership and investment. And China does not like that. And so there is a sense that Manus is being made an example of here with that. But I also think at a time when there has been a huge craze in China for OpenClaw, which is another AI agent app, very much like Manus, which was originally developed in Europe for enabling individuals to create new kind of personal AI agents that run on their desktop and carry out a bunch of tasks for users. This is really the new frontier in AI at the moment.

4:05And if Manus was going to be one of the leading parties from a Chinese developer for that, then Beijing probably wants to keep that local. Now, like I mentioned, Tim, this deal was done. So how easy is it going to be to undo? I don't know that anybody has a very good idea about that yet. It's going to be a very complicated one. The scenarios are that Meta either has to find a buyer, like a new entity that will take on Manus, sort of spin it off with new backing. It's unclear where that would come from or even persuade the investors that backed it originally to take it back, some of which were American VC firms like Benchmark, which by and large are being strongly discouraged from investing in Chinese AI companies.

4:49And if Beijing is stamping this as a Chinese AI company, by making this move, that will complicate efforts for Meta to try and get their money back from Manus' original investors. And what does Meta have to say about China stepping in and breaking this deal up? Meta has actually said very little about this, not perhaps wanting to get into too public a fight with Beijing just yet. They say that the transaction complied fully with applicable laws and they anticipate an appropriate resolution. That seems somewhat optimistic at this point, but we shall see how things proceed from here. It'll be very interesting to watch.

5:22Given this drastic measure taken by the Chinese government, what does it tell you about the race to dominate the AI field? It's definitely a blow to Meta, which had been investing very heavily in all sorts of ways to catch up with the likes of Google and OpenAI. And this was clearly a very talented team and the AI race is very much about talent. And so if there are greater blocks on US companies pulling in talent from China, then that is going to complicate a lot of the research efforts that are ongoing with Chinese nationals that work quite legitimately for American companies in Silicon Valley.

5:56But I think also it just kind of shows how much the sovereign AI war is really heating up. And that is one that's being fought between Washington and Beijing primarily. But every government is trying to figure out what their own AI strategy is. So as governments get very anxious about what AI might do to their economies in the future and whether they're going to have a foothold on that growth engine, I don't think this will be the last national intervention that we see of this kind. That's EFT's Tim Bradshaw in London. Thanks, Tim. Thanks, Mark.

6:35Institutional investors are sounding the alarm about deals where private equity firms sell companies back to themselves. The investors say this type of trade could result in conflicts of interest. But these sweetheart deals, also called continuation vehicles, have become very popular recently. The FT's private capital reporter, Alex Hill, joins me now to explain. Hey, Alex. Hi, how's it going? Yeah, not bad. So, you know, what exactly is going on here? So private equity traditionally raises a fund from institutional investors like pension plans or endowments or sovereign wealth funds. And they use that fund to go and buy maybe 10 or 12 companies.

7:16They hold those companies for about five years, ideally, and then they will sell them, hopefully a profit. And then they obviously use the proceeds of the sale to give the money back to their investors. A continuation fund, on the other hand, is where the private equity firm raises a new fund that they will also manage to sell a company from the firm's existing fund into this dedicated fund that's set up just to buy that one asset. And effectively, it involves the private equity firm selling to itself because it is on both the sell and the buy side of the transaction. Got it. So why are private equity firms doing this at all?

7:58So it really started during the first year of the pandemic, where deal making in general was difficult. And private equity firms were still under pressure to return cash to the backers of the funds that owned all the companies that they had bought. And so they started turning to this structure as a way of realizing money on these assets without selling them at valuations that they thought were too low. Then 2021, there was this huge deal-making boom. But then in 2022, interest rates rose. And since then, private equity firms have found it very difficult, in many cases, to sell companies at the valuations that they think they're worth.

8:37On the flip side, have also been turning to these structures as a way of holding on to what they see as star-performing assets that they don't want to just have to sell in five years when the original investors are demanding their money back. They want to be able to stay exposed to the potential long-term upside of that company. Now, I mentioned earlier that some investors aren't super hot on this idea. Why are these deals controversial? So continuation vehicles are controversial because the same private equity manager is on both the sell and the buy side of the transaction. And that leads to fears that they could be putting their finger on the scales to tip the price in either way that's convenient for them.

9:17The conflict that hasn't yet much been written about and that investors really starting to sound the alarm on now is that there are some private capital firms out there called multi-strategy firms and they both invest in the traditional funds of private equity firms in one business line but they also buy or back continuation vehicles from another business line. And that could mean that representatives of that firm, they might be sitting on the committee of the selling fund that needs to vote through the continuation vehicle while their employers are going to back the same continuation vehicle.

9:54So that means that the investors in the funds are on both sides of the transaction. So Alex, does this tell you anything about the health of private equity at the current moment we're in? So private equity is in quite a difficult spot at the moment. Since interest rates rose, it's been very difficult for a lot of private equity firms to sell companies. They bought a lot of companies at really high valuations during the decade when interest rates were low or almost rock bottom. And now they've got to try and sell those assets to be able to return cash to the investors who helped them to buy them.

10:31And as that's become more difficult, they are now having to kind of come up with new ways of generating liquidity on all of these companies that they had bought. The private equity industry itself would say this is also partly an innovation that's just a result of the industry growing so much. So as the industry grows, more companies are staying private for longer, not listing on stock exchanges. There is just natural innovation to be able to produce liquidity and be able to buy in and out of these assets. But really, it remains to be seen just what private equity will do and just how they will be able to generate cash back on all of these assets that they own.

11:12Alex Hill is the FT's private capital reporter in London. Thanks, Alex. Thanks so much for having me.

11:21You can read more on all these stories for free when you click the links in our show notes. This has been your daily FT News briefing. Check back tomorrow for the latest business news.

11:55You don't ask for a second opinion. You don't wake up thinking about a filing. Because Avalara's Agentic AI handles it. Calculating, filing, validating. With the accuracy and audit defensibility your team can stand behind. Avalara. Agentic AI tax and compliance with confidence. If you've got a teenager, it's time to have the talk. You know, about investing. With the new Schwab Teen Investor account, teens can gain hands-on investing experience and build positive money habits. It's an account co-owned by you and your teen, so you can monitor and engage with the account while your teen learns how to invest and manage money.

12:34Learn more at schwab.com slash teen.