Jeff Diehl: The View from SuperReturn Japan, Part I

Jeff Diehl: The View from SuperReturn Japan, Part I

On Wednesday, December 5, in Tokyo, Japan, the SuperReturn Japan 2018 event convenes. CAIA is a sponsor of this event.

Jeff Diehl, managing partner at Adams Street Partners, a multi-national investment manager with more than $35 billion in assets under management, is attending. He will participate in a panel Wednesday afternoon, asking “Where are the opportunities in Europe and the USA?”

AllAboutAlpha spent some one-on-one time with him to get a sense of what the world of private equity and venture capital (the focus of the Tokyo event) looks like from the point of view of a firm that, like Adams Street, can fairly be called “venerable.” In a field with a lot of closings and transformations beyond recognition, Adams Street has been around since 1972. In the late 1980s it played a critical role in the creation of valuation guidelines for the PE industry, and in 2001 it spun itself out of parent UBS, becoming independent and employee-owned.

So forthcoming was Diehl, that we will present his thoughts in two parts. This post will offer our Q-and-A with Diehl on the state of PE/VC investing globally, and in the context of Japan more specifically. Part II will look at the present China-US trade tensions and Diehl’s take on their impact in the present and near future.

AAA: Could you start by telling us something about your experiences before joining Adams Street Partners? And how did it happen that you came on board? Did Mr. French recruit you? [The reference is to T. Boudurant French, chairman of the board at Adams Street.]

Diehl: I joined Adams Street Partners in late 2000 just before we spun out of UBS Asset Management to officially form the firm. I joined as a partner on our direct investment team where my initial role was to invest in promising growth-stage technology companies in the United States. The timing of my joining Adams Street in 2000 was opportunistic because that same year my wife and I relocated from Boston to Chicago for family reasons.

Terry Gould, who leads our direct investment team, recruited me to join the firm.  Prior to Adams Street, I spent three years at Parthenon, a Boston-based strategy consulting firm where I worked with growing technology companies and portfolio companies of Parthenon Capital, a growth equity fund.

AAA: Turning to the VC space in general: There was some discussion a few years ago of a theory that VC and PE investment was becoming more important and central to the financial system in the US especially because the public exchanges, and the IPO system for getting listed there, was seen as “broken”—too easily gamed by algorithms and hyper-fast traders, prone to technical breakdowns, etc. Would you agree with the view that the respective roles of public listings on one hand and private investments on the other hand been changing in recent years, and do you think that the theory of broken exchanges helps us understand the reasons for the changes?

Diehl:  For several decades, venture capital and private equity have been driving forces behind growth, transformation and job creation in industries going through change and dislocation. We know that public companies have structural and governance constraints that limit their ability to creatively destruct themselves or an industry. This said, there are exceptions (such as Amazon) that have had tremendous success. The fundamental disruptor of industry changes is technology. It has advanced to the point where it is infiltrating and redefining nearly every industry, so it is natural that private markets play an increasing role.

However, I wouldn’t say the exchanges are broken—they remain an important source of long-term capital and liquidity. An IPO is not an exit, but rather a financing/liquidity event. As an alternative, a quicker path to a full exit is clearly to sell to a private equity firm. The transition process from a private to a public company is hard and there is a lot of preparatory work and cost.

Securities regulatory bodies have a hard job because they are constantly trying to balance protecting retail investors while ensuring those same investors aren’t locked out of great investment opportunities. Regulators have done a very good job of working with our industry to ensure they strike the right balance, including relief for newly minted IPOs. Nevertheless, the regulatory pendulum can swing with market cycles.

In terms of trading algorithms and high-frequency trading, our industry thankfully doesn’t consume much brain energy on this. It goes with the territory and has little impact on our ability to generate good returns.

AAA: You’re participating this week in the SuperReturn Japan event. What can you say in general about the state of the PE/VC markets in Japan? Again, allow me to flesh this out with reference to one theory I’ve encountered. For demographic reasons a lot of founders of small- and medium-sized enterprises in Japan are retiring these days (so it is said). They want to find buyers, because they’d rather pass on to their heirs the money value of the enterprise than the enterprise itself, and this has meant that PE/VC firms operating in the country and looking for assets have had their pick of opportunities. Is that fair? And on the other side, where is the money for PE/VC activity in Japan coming from? Outside investors or homegrown?

Diehl: The Japanese PE/VC market is growing in its importance. However, the market is still dominated by public companies and family-owned/operated businesses. Despite its current minority status in Japan, private equity has all the elements necessary to succeed in Japan and we see strong domestic and international institutional investor interest. Japan is an optimal place for private equity to succeed—the country has clear property rights, rule of law, low inflation, a stable currency, a democracy, and an educated and motivated population.

The decision to sell a family business versus passing it on to one’s heirs is a deeply personal and emotional decision with a lot of complex factors at play. So, while it is easy to say that private equity is growing in both acceptance and market share in Japan, it is hard to predict how this will trend in the future. The bottom line is that it is fair to say that there is an opportunity for private equity firms to generate interesting returns in Japan.

I would bet that the private equity firms who will have the most success in Japan are ones with: (a) dedicated resources on the ground in Japan who are building relationships with family owner/operators; (b) a proven track-record of adding value in those industries; and {c) a reputation of being a good partner who treats employees of acquired companies the right way. While we see high-quality private equity firms that are country-specific, pan-Asian, and global, what ultimately matters most is having high-quality and value-add investment professionals on the ground.



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