A highly sought-after but highly competitive asset. Middle-market private equity in the U.S. is a space that has been drawing attention in the Chilean financial industry for some time, where alternative assets are becoming increasingly relevant within investment portfolios, both institutional and private.
Thus, bringing together what they expect will be many more in the future, the alternatives-focused boutique Arcalis Toesca , a joint venture of Arcalis Capital and Toesca Asset Management, gathered the local financial industry for the first event focused on middle-market private equity in Latin America. At the Ritz-Carlton hotel in Santiago, and before a full audience, the event served as a showcase for a variety of investment firms dedicated to the U.S. middle market, offering a range of investment philosophies, processes, and sectors.
Representatives from Kinderhook Industries, K1 Investment Management, Tenex Capital Management, Lee Equity Partners, Gridiron Capital, Lightyear Capital, Apogem Capital, Ridgemont Equity Partners, Monomoy Capital Partners, The Sterling Group, Arsenal Capital Partners, and SK Capital Partners presented their firms and the strategies for which they are raising capital.
The conference painted a picture of specialization in a space that is highly demanded by local LPs, but also highly competitive. “There are more private equity firms than McDonald’s,” said Neil Malik, co-founder of K1, drawing laughs from the audience. In that sense, the executive sees it as difficult for the industry to keep growing, placing it at a “cyclical peak.”
Even so, the U.S. middle market remains attractive. Part of this, explained Kevin Jackson, Managing Partner of Gridiron Capital, is due to it being a very large market, with thousands of companies across all sectors. In that regard, the executive emphasized the particular importance of relationships in this space to capture more attractive opportunities.
Thus, to navigate a sea of mid-sized companies, often family-owned, there are cross-cutting factors to consider, such as the importance of origination, sector expertise, and the possibilities that artificial intelligence opens up to transform portfolio companies.
The push for proprietary pipeline
As with private markets, origination is key. The high level of competition, in an environment with more than 3,000 private equity firms, means that the ability to find attractive deals becomes one of the core competencies in the industry.
“Every manager says they have proprietary pipelines, and it’s mostly true,” joked Christian Michalik, Managing Director at Kinderhook. Considering that the mission of private equity firms is to originate attractive deals for their investors, he noted, the ability to generate these deals is crucial.
At a later stage, another key mission for firms is value creation. Operational transformation, in that sense, is a fundamental tool for companies in the sector. “That’s how you move the needle in the middle market,” said Mike Green, CEO of Tenex Capital Management.
A common message during the conference was the importance of investing in businesses that are familiar to the firm, where expertise plays a key role in value creation.
Familiar niches
To achieve that desired value creation, the stance of the managers gathered by Arcalis Toesca is to focus on specific sectors where they have significant experience. “Sector expertise is very important in the middle market,” emphasized Michael Petrzela, partner at Lightyear Capital.
While there is a temptation to invest in “sexy” areas, trendy themes that capture market interest, it is better to focus on businesses they understand, as highlighted by Robert Michalik, Managing Director at Kinderhook.
From Ridgemont Equity Partners, partner Jack Purcell agrees with the importance of experience in the industries in which they invest, especially in the current market context. “The formula for this environment is different from ten years ago,” he said, adding that “this is not a market to be a sector tourist.”
The industrial revolution of AI
Of course, there was no shortage of discussion about the investment trend of the moment: artificial intelligence.
Beyond investing in companies dedicated to this technology, private equity firms are showing interest in the various ways this technology could improve the operations of their portfolio companies.
“AI will help us have better processes and operations and remove costs along the way,” highlighted Mark Gormley, partner at Lee Equity Partners, which could lead to “better economics.”
“It’s a great opportunity, but also a risk,” said Malik of K1 Investment Management. The firm’s approach has been to add artificial intelligence to its portfolio companies, either by incorporating it or through in-house developments.
That said, looking at the valuations surrounding some companies in the space, particularly the hype around LLMs, the executive anticipates a price adjustment. “In my opinion, we are on the verge of a correction,” he said, which could open a window of opportunity: “When capital becomes scarce again, that’s the time to invest again.”
