Private equity recycles assets

0:02Good morning from the Financial Times. Today is Thursday, July 24th. This is your FT News Briefing. Tesla seems like it can't shake the bad vibes, and private equity firms are recycling their assets. Plus, Taiwan will hold recall elections this weekend, and the outcome could mean a lot for its relationship with China. I'm Mark Filippino, and here's the news you need to start your day.

0:36Tesla saw last quarter's profits fall 23 % year-on-year. The carmaker said yesterday that electric vehicle sales are continuing to slide. And that's due to a few things we've mentioned on the show before. an aging model lineup, more competition from China, and a consumer backlash against CEO Elon Musk's political activities. And even though Musk promised to refocus his attention on Tesla, he's still fighting with U.S. President Donald Trump. Musk even threatened to start a third political party. Now, all this tumult seemed to get to investors. Tesla's share price dropped nearly 5 % in after-hours trading yesterday.

1:21Private equity firms are struggling to offload their assets. So they've increasingly been turning to a controversial tactic, selling those assets back to themselves. Nearly 20 % of all sales by the industry use this strategy in the first half of this year, which is a new record. But the tactic is not super popular with investors. And that begs the question, how long can it last? Antoine Gara is the FT's U.S. private equity and deals editor. He joins me now to unpack this. Hey, Antoine. Hi, how are you? Doing well. So, you know, tell me about this strategy. How does it work? Yeah, a continuation fund, essentially a private equity fund raises a new fund from their existing sort of quote unquote flagship funds.

2:08It raises capital from third party investors. And then that new fund will have enough capital to then buy an individual investment out of one of the private equity firm's prior funds, like an investment that all the people really like, a very good, strong investment. So they're buying an investment from one fund to the other at a new set valuation, and it gives the existing investors in that fund that's selling the option to either take cash or roll their investment into the new fund. I see. And why have these gotten so popular? It's basically because it's been hard to exit investments the other way through initial public offerings.

2:52And corporate buyers are also kind of sitting on the sidelines. Moreover, there's this huge market for private equity firms to sell their investments to other private equity firms. But there's a big gap in bid-ask spreads or the valuation that people want to trade at. It sounds like a win-win for the firms and the investors. investors can cash out and PE firms can keep companies on the books for longer. What is the concern here? A win-win is a very optimistic way of looking at it, but there's truth to that. Yeah. The reason it can't be seen as a win-win is the new investors are coming in at a set valuation and the old investors have the choice to take the cash or re-up their investment at the new valuation.

3:36So there's a new mark. It's not kind of made up, But the negatives are it forces the existing investors to make a choice that they wouldn't actually have had to make in the past. Sometimes they can't really have the resources to make that decision very quickly. And then the incentives can be kind of skewed to the private equity firm because the new fund will charge a whole new set of fees. And when they sell the asset, it also crystallizes gains. And so that can kind of skew the PE firm to want to do these deals. So if calling continuation funds is a win-win, a bit of a stretch, is PE going to keep doing this?

4:15Is a strategy something that you see happening long term? What people are saying is this is going to become an ever more sort of mainstream part of the fabric of the industry. And I don't think there's much optimism that IPO markets are going to go back to the way they were in the 1990s when, you know, there were just hot IPO after hot IPO. So, yeah, I think that this is going to be a very big and important part of how people get out of their private equity investments for the foreseeable future. Sure. Antoine, if investors aren't super hot on this idea, but PE is, where does that leave the industry?

4:53Well, the industry still has to figure out how to exit their old deals. There's about three trillion plus of old deals, and they can't rely on continuation funds to do all of it. They can rely on continuation funds to do a very small minority of it. So they need to figure out how to take companies public, how to find corporations that are willing to buy their companies, or they have to come up with the right price at which they can sell to other private equity firms. And we've been waiting years for that really to happen. Antoine Gara covers the private equity industry for the FT. Thanks, Antoine.

5:28Thank you.

5:55Thank you. investment in Chinese tech groups. Losing out on this generative AI consulting might be a problem for McKinsey. The technology now plays a central role in lots of corporate strategy and IT systems, and one person with knowledge of McKinsey's policy said it might affect the firm's ability to get new business.

6:22Taiwan's main opposition Kuomintang Party has been on a roll. They became the largest party in parliament early last year, and the KMT used its position to block President Lai Xingte's government at every turn. But it faces a reckoning. A lot of KMT legislators are facing recall elections this weekend that could threaten the party's parliamentary majority. DFT's Catherine Hilla has been covering this from Taipei. Hey, Catherine. Hi. So first of all, Catherine, can you just explain what a recall election is and why it's being held in Taiwan now? So a recall election is a vote to allow voters to basically change their mind about someone they elected earlier, if a certain number of signatures for this recall vote have been collected, so a petition.

7:09So this process is in Taiwan's constitution. So it has been used before in individual cases where voters were dissatisfied with the performance of, say, a mayor or an individual lawmaker. But what has happened this time around is that there has been a wave of protests against the largest opposition party and this big push to try and recall as many of them as possible. So what we have now is 31 of the 52 KMT members of parliament face recall votes, the majority this Saturday and then the smaller number next month. Now, why have so many voters turned against the KMT? So after becoming the largest party in parliament last May, they tried to broaden the powers of the legislature at the expense of the executive.

7:59That was later barred by the constitutional court. It was found unconstitutional. but they also changed the laws in a way that have effectively resulted in paralyzing the constitutional court. So any further legal changes that the opposition pushes through will face a situation where the government can do nothing about it because the court can't rule on these things. So all of this taken together has created the impression with many people that the KMT is trying to systematically undermine the functioning of government and Taiwan's democracy, that suggests that they're a lot friendlier with China than is prudent in the current situation, because China wants to make Taiwan part of the People's Republic, and Taiwan's public resists that.

8:48Can you just back up for a second, Catherine, and give me some details about why some people in Taiwan consider KMT as being too friendly towards China? Separately, several KMT politicians, including the former president and a large number of their lawmakers, have engaged with China quite closely. They have been making frequent visits to China. They have also echoed a lot of Chinese rhetoric about the relationship between China and Taiwan. And for example, China frequently conducts large-scale military maneuvers around Taiwan and issues menacing statements against Taiwan. And many KMT politicians, when they talk about this, the first they blame for these rising tensions is Taiwan's own government.

9:37And this makes them, well, open and vulnerable to criticism that they are indeed pro-China and not pro-Taiwan. So what does the future look like for this party if it does lose its majority in parliament as a result of the recall election? So the result of the recall elections is almost impossible to predict because they are on this scale unprecedented. But if the party loses heavily, there is a chance that it could spark pressure for more reform internally and force through adjustments in the party's stance on China. But one longer term significance of this vote is, of course, also internal societal cohesion in Taiwan, because this whole campaign has deepened political polarization.

10:26So there's a question mark over what bipartisan relations will look like after this vote. Catherine Hilla is the FT's Greater China Correspondent. Thanks so much, Catherine. Thank you. Great to be here.

10:44Before we go, if you have questions about U.S. politics and the economy, you should send me an email. Let me know what you're curious about, your name and where you're from, and we'll get you some answers on the Swamp Notes podcast that I host. And if you drop us a voice memo of your question, we might play it on the show. Just send us your questions to my email address in the show notes.

11:06You can read more on all of these stories for free when you click on the links in our show notes. This has been your daily FT News Briefing. Check back tomorrow for the latest business news.

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