WHARTON PRIVATE EQUITY & VENTURE CAPITAL Volume 1 / Issue 5
IN THIS ISSUE: 1. Blackstone Stuy-Town Acquisition 2. Revolutionizing Money Transfers 3. A Wild Goose Chase 4. VC in India and China 5. Rise of Robo Advisors 6. Carried Interest
Author Suyash Hodawadekar Class of 2018 suyh@wharton.upenn.edu
BLACKSTONE ACQUIRES MANHATTAN’S LARGEST MULTI FAMILY COMPLEX During this past October, Blackstone closed a monumental $5.3 billion deal for New York’s Stuyvesant Town-Peter Cooper Village: the largest rental complex in Manhattan. The real estate market in New York has been going through a long period of increased rents, and complexes such as the Stuyvesant Town-Peter Cooper Village are beacons of hope for middle class families who are in the market for affordable housing. As a result, Blackstone has struck a unique deal with Mayor Bill de Blasio’s administration in which the private equity goliath would agree to keep roughly half of the apartments in the complex affordable for middle class families for the next 20 years. Such a large deal is understandable coming from Blackstone, which is currently the largest real estate private equity firm in the world with $101 billion assets under management. In addition, it is also the largest owner of single-family residential properties in the United States. It is evident that the acquisition of Stuyvesant Town-Peter Cooper Village is Blackstone’s first major attempt to diversify its portfolio into the multi-family sector. Unlike most of Blackstone’s funds that have a holding period of 7 to 10 years, the acquisition of Stuyvesant Town-Peter Cooper Village will be done through Blackstone’s first fund for core plus real estate, which can hold assets for decades. Prior to the acquisition by Blackstone, other large investment firms also saw the potential of Stuyvesant Town-Peter Cooper Village. In 2006, BlackRock and Tishman Speyer bought the complex with the main intention of taking advantage of New York’s growing rents. The $5.4 billion that Tishman Speyer paid for Stuy Town in 2006 is still, to this date, the most expensive single asset sale in history. Unfortunately, the real estate market took a turn for the worst and the two investment firms had to forego their position in the residential complex in 2010 when they had to default on a $3 billion mortgage. CWCapital, Stuy Town’s owner prior to the Blackstone deal, still did not have much success with the complex. Prior to Blackstone’s deal with City Hall, there were already roughly 5200 rent controlled apartments in the complex; however, the complex had been losing approximately 250 to 300 apartments annually as a result of either the tenant’s death or relocation. Due to a provision in the affordability agreement, the vacant apartments would then be stepped up to market rent rates. In order to combat the decline of affordable rent properties in Manhattan, the Administration decided to strike a deal with Blackstone.
Of the 5000 units that were obligated to have affordable rents, 500 units were reserved for families with an average annual income of $62,000 or less. Such apartments would have a monthly rent of $1500 for a standard two-bed room apartment. The remaining 4500 units would have monthly rents of $3200 and be reserved for families generating annual incomes of $128,000. This provision aligns with Mayor Bill de Blasio’s promise to save 200,000 units of affordable properties. In exchange for creating the positive externality of affordability in Manhattan, Blackstone did not have to pay $77 million in mortgage recording taxes and received a $144 million low interest loan from the city. In addition, Blackstone is not required to keep the rents of the remaining 6232 apartments affordable. After a press release from Jonathon Gray, Blackstone’s Global Head of
Real Estate, it is evident that firm plans to hold the residential complex for a long period of time. Blackstone has strategically acquired a property in which the future prospects of sale are very promising. As of the third quarter of 2015, the cap rate for mid-rise/high-rise apartments in Manhattan was 3.8%, compared to the U.S average of 5.1% for the same property types. Given that Blackstone plans to hold the residential complex for decades, it can take advantage of the relatively low cap rates in Manhattan. If the going-out cap rate, which is the inverse of an exit multiple, is low enough 20 years down the line, Blackstone can reap enormous profits at sale. It is clear that the $5.3 billion deal for Stuyvesant TownPeter Cooper Village not only promotes Mayor Bill de Blasio’s initiative to retain affordable residential units in the city, but also adds another valuable property to Blackstone’s reputable real estate fund.
Stuyvesant Town-Peter Cooper Village
REVOLUTIONIZING MONEY TRANSFERS Business and Industry Overview
Author Sadhvi Venkatramani Class of 2019 sadhviv@seas.upenn.edu
InstaReM, stemming from the words “instant remittance,” is a company that provides and manages a digital payment platform in Asia. Their system focuses on allowing its customers to send money from their account to another account in any country within Asia. CEO Prajit Nanu and COO Michael Bermingham founded InstaReM due to frustration with the experiences they faced with sending money abroad. Based in Singapore, InstaReM now has a twenty person team, locations in Sydney, Singapore, Mumbai, and New Jersey, and 17 bank partnerships. Their customers include individuals, small and medium-sized enterprises (also known as SMEs, which, for example, employ less than 250 people and have an annual balance totaling no more than 43 million euros, as defined by the European Commission), and financial institutions. Individuals like immigrants find this service attractive while SMEs, which make up about 20 percent of InstaReM’s customer base, also use it for the reduced costs and faster transaction processing. In addition, some medium-sized establishments find InstaReM useful for the possibility of increasing their handling of transaction volumes. InstaReM focuses on being fast, compliant, and low-cost in the money transfer space. The average transaction amount is about $1800 on InstaReM, and it can be processed in just a few hours instead of the 24 to 48 hours required by most other transferring platforms. InstaReM also has a different pricing strategy for its services; that is, they charge a percentage of the transaction (usually less than 1 percent) instead of both the transaction fee and FX spread/conversion fee (based on bid and ask prices) done by others. The reason InstaReM is able to do this is because they work with mid-size banks that already trade using foreign currencies, helping cut costs and inefficiencies while increasing liquidity. Other payment processors like TransferWise set up multiple bank accounts that they then use to send money across different countries, with their customers’ transactions as the float. This approach tends to increase transferal time and the company’s costs. In less than a year, they have gained about 2 percent of all transferals from Australia to India. Furthermore, InstaReM has licenses in Australia, Hong Kong, and Canada, and is in the process of receiving one in Singapore, Malaysia, Japan, Luxembourg, and certain U.S. states
Funding and Investors In mid-March, Vertex Ventures, based in Singapore, along with Fullerton Financial Holdings (FFH) and Global Founders Capital (GFC) conducted a Series A investment of $5 million in InstaReM. The first round of Series A financing usually occurs after a newly-begun venture has used seed capital. Therefore, this was the first time that an equity stake in InstaReM was offered openly to outside investors. The managing director and general partner at Vertex Ventures stated that they found InstaReM’s integration with banks and ability to carry out tasks impressive given the complexities of the fintech space in Asia. Furthermore, the rapid growth of the company itself – from being relatively unknown to one of the leading digital payments services in Australia – also led to both its need and receiving of funding. Vertex Ventures is the venture capital branch of Singapore’s government-run fund, Temasek Holdings. FFH, a direct subsidiary of Temasek, which is an investment company that invests in innovative companies in financial services in Asia and other emerging markets.
GFC, a fund based in Luxemburg that focuses on seed and series A investing, was an early investor in InstaReM.
their ability to keep costs low while increasing speed. Continuing to deepen these relationships could serve as their major advantage.
Effects and Plans
The investment in InstaReM will assist with licensing, geographical expansion, scaling the platform, technical development, and marketing. Rapid growth being one of their strategies, InstaReM’s recent funding may accelerate the process of entering new countries and getting in front of potential consumers. This previously unheard of name may become the leader in digital payments in Asia soon, for its modern approach of combining low cost, high speed, reliability, and convenience, appeals to a broad audience. Yet, in order to understand the extent of InstaReM’s advantage and possible dominance, it is essential to first gauge the level of importance consumers place on these enhanced capabilities.
The CEO of InstaReM is aiming for $100 million monthly in transaction volumes by the end of 2016. InstaReM plans to focus on volume rather than higher margins per transaction. They would like to reach one billion dollars in transactions in two and a half years, versus the average four years it takes for similar companies. They plan to expand in both large markets and more secluded ones, such as Nepal and Bhutan. Furthermore, they are working on new products and services which they would like to introduce to the “unbanked populations” and strong networks of South Asia. Integrating with banks seems to be a key aspect in
Comparison of Pricing Differences
A WILD GOOSE CHASE If you ever took a stroll down Locust Walk anytime this past winter, there was a good chance you saw a stream of people walking by wearing Canada Goose parkas with the signature logo patch on the left arm.
Author WenTao Zhang Class of 2019 wentaozh@wharton.upenn.edu
Canada Goose, the wildly successful company behind the high-end parka, has sold a majority stake to private equity giant Bain Capital in a move that allows it to have the cash and manufacturing prowess to push into new markets in the US ad overseas such as South Korea. This move comes just weeks after Moncler, the chief rival of Canada Goose, set the price range for its IPO. The imminent Moncler IPO on the Milan stock exchange is due to make a handsome profit for the Carlyle Group, which is a big investor in Moncler. Although the terms of the transaction were not openly discussed, it has been unofficially claimed that Bain’s equity purchase valued Canada Goose at approximately $250 million, according to grandson of the CG’s founder and current CEO Dani Reiss. Despite market pressure and cheaper labor abroad, Canada Goose currently operates production facilities exclusively in Canada and is committed to keeping manufacturing and processing in-country. This is because Canada Goose executives, as well as new investors and marketing industry veterans, believe that the dedication to made-in-Canada authenticity has been at the core of the company’s furious 50% growth this past year and helped it land its product on the cover of Sports Illustrated’s 2014 swimsuit edition, where Kate Upton wore only a Canada Goose parka. When Mr. Reiss went to the market in search of investment, he said he was explicitly looking for a partner who would agree with keeping production in Canada and avoid the “cheap chic” lead of many other appeal companies which have moved production to Bangladesh, where costs are low but accidents are frequent. “It is a very fast-growing, very high-end, very high-margin [business] … Dani has been very careful about the brand. If anything, the growth could have been more if he wasn’t as careful about the brand. He’s done a very good job at supply and and where [the product] is found.” The company is most famous for its popular high-end parkas, which are made from goose down sourced from Hutterite farmers across rural Canada. It comes with coyote fur-lined hoods and can cost upwards of $1,200. Maintaining Canada Goose’s high-end brand, while expanding from the polar explorers that once formed the company’s niche, has been Mr. Reiss’s legacy since taking over from his father in 2001. The company has grown steadily in the past decade, increasing annual revenue from about $5 million in 2001 to roughly $300 million in 2015 (50% CAGR). The firm now has over 1,000 employees and targets 50 different international markets. Interestingly, Canada Goose has experienced significant growth in warmer climes such as India and across the Middle East, where many people purchase the brand as a symbol of their power and wealth.
VENTURE CAPITAL IN INDIA AND CHINA India and China are two of the fastest growing nations in the world. These two countries are behemoths of the modern economy. The mix of rising rates of growth and sheer size, marks these countries as prime targets of venture capital. However, where return is high, so is the risk and so both nations have had interesting receptions to venture capital.
Author Rahul Sood Class of 2019 rsood@seas.upenn.edu
Venture capitalism in India began in 1986 with the start of the economic liberalization. In 1988, the Indian government formalized venture capital by issuing a set of guidelines. Initially, venture capital was limited to subsidiaries set up such as IDBI, ICICI and the IFC, and focused on large industrial concerns. In China, venture capital firms have continually injected money from the point when the country started to become a market power in the 1980s. In 1984, the National Research Center of Science and Technology for Development encouraged the Chinese government to establish a venture capital system to promote technology growth. Most of the 1980s venture capital was focused on infrastructure and property investments. Although there were many intense efforts to develop the industry, inexperience of the government and entrepreneurs led to somewhat modest results. However, in 2002, the Chinese Venture Capital Association, CVCA, was created and the market has experienced extensive growth ever since. The CVCA is a member based trade organization made up of experienced investors with the goal of promoting the development of venture capital and private equity in China. In the 1990’s significant input from start-ups by Indians in the Silicon Valley indirectly proved to investors that India had the talent and the scope for economic development and growth. Over the years, more and more private investors from India and abroad have entered the Indian venture capital market. Just as with China, in the early stages, venture capital investments were mainly in the manufacturing sector. However, with changing trends and increased liberalization, companies in the consumer services and consumer retail space emerged as top contenders for VC funding, attracting almost 50% of total VC investments. Other key industries included IT and IT-related services, software development, telecommunications, electronics, biotechnology and pharmaceuticals, banking and finance/insurance, public sector divestment, media and entertainment, and education. In recent times however, the worry of an economic bubble inflated by expectation of these growing nations has resulted in a changed mentality for investors. According to Navin Chaddha, managing director of Mayfield Fund, which has investments in both India and China: “The lines between venture capital and private equity are blurring.� While both nations have huge entrepreneurial resources, most of the money is going to these larger deals. The issue of government and policy has also been a barrier to foreign investors. In particular, China and India host very unfamiliar regulatory procedures and security for IP, which makes investors wary.
THE RISE OF ROBO ADVISORS When one wants advice on how to invest their money, they will often go talk to a financial advisor. Perhaps this advisor works for a big bank, or maybe they operate on a fee only basis. A new trend, however, are financial advisors that are not even human—they are computers that run millions of algorithms to pick optimal investments. In the new era, the “robo advisor” can allocate the portfolio to the investor’s taste, optimizing for efficiency.
Author Hersh Solanki Class of 2019 hsolanki@wharton.upenn.edu
The venture capital industry has funded various robo advisors, including Betterment, Motif Investing, Wealthfront, and FutureAdvisor. Betterment “has received $100 million from venture capital investors, pushing its valuation to $700 million, nearly double its value this time last year.” Even though the VC industry as a whole may be cooling off, the investment in robo advisors has been hot. The biggest point of differentiation is that “Right now, the robo models are in the ascendancy, grabbing market share, while the old bulls are hustling to build competing products.” It’s important to realize that there has been a massive push towards passive investing. The millennials are well educated, but often don’t have time to actively manage their portfolios. As a result, they can choose to give their money to a firm like Betterment, which algorithmically provides solid returns. By capitalizing on market inefficiencies quicker than any human, often times passive indexing is the preferred option; of course, one can invest in hedge funds if they have the risk tolerance and capital, but many choose the former option. Venture capital funding is not only big in the United States. According to Finextra, “Munich-based digital investment manager Scalable Capital has secured £5.6 million in funding to support its forthcoming launch in the UK.” What differentiates Scalable is that it uses unique risk tolerance to build out portfolios. By capturing upside while limiting downside, Scalable has secured funding from some of Europe’s top firms, such as Holtzbrink Ventures and Monk’s Hill Ventures. Scalable has created what is known as a moat, by creating unique algorithms to personalize investments, with high barriers to entry due to likely patenting of the technology. Looking into the future, “As robo "builds out" it is expected to capture trillions in assets. Consulting firm A.T. Kearney expects robos to manage as much as $2.2 trillion by 2020. A report from Deloitte released in December estimates robo services will manage $5 to $7 trillion within a decade, up from under $100 billion today.” The machine learning algorithms help the robo advisor learn from itself, meaning that it only gets smarter as time goes on. As it gets smarter, it will get more money under management, especially from the millennials. It is important to consider that algorithmic trading isn’t just being brought to the market—it is now being brought to the masses. For many years, hedge funds have engaged in high frequency trading, often to the loss of every day investors. The tables have turned, and the machine intelligence is now available to whoever wants it.
THE CARRIED INTEREST CONTROVERSY Probably the largest reason why elite private equity managing directors can make tens of millions or even billions of dollars in just one year is because of private equity’s ability to pay relatively low taxes due to something called “carried interest”. The term is derived from the practice of ship captains charging 20% on the valuable cargo they shipped between the New World and Europe.
Author Frederick Jordaan Class of 2018 jordaanf@wharton.upenn.edu
Today, the media is framing carried interest as a tax loophole that allows the rich to get richer, however experts in the field point to its necessity in spurring long-term investment. Carried interest reform seems to be the only topic uniting all three Republican presidential candidates at the moment with all three indicating their support to reforming the current tax code which is helping hedge funds, private equity firms, and venture capitalists avoid billions of dollars in taxes each year. But what really is carried interest, and why is it controversial? Carried interest is a rule in the tax code that lets investors and managers of investment funds – hedge funds, private equity, venture capital, real estate, etc. – pay a lower rate than most individuals. The general fee structure for hedge funds and private equity firms is “2 and 20”. The firm takes an automatic 2% cut on investments, plus an additional 20% incentive fee on realized gains over benchmarks. While the 2% is treated like ordinary income and is therefore taxed accordingly under income tax. On the other hand, the 20% incentive fee is deemed “carried interest.” The current rate for carried interest caps at 20% rather than at 40% for ordinary income. While obviously controversial, defenders of the carried interest rule argue that it promotes entrepreneurial risk-taking. For example, Venture Capitalists take extra risk to support early stage startups and Private Equity firms take over failing businesses. Also by categorizing profits as carried interest and not income, it encourages investors to put the capital to productive use. In a piece defending the arrangement, the Steve Judge, CEO of Private Equity Growth Capital Council mentioned, “The capital gains rate exists to provide incentive for investment partnerships to take risks, invest hundreds of billions of dollars of capital into new and existing businesses and contribute operational expertise to improve these businesses over time.” However, others are not convinced, last year the Tax Policy Center released a statement which said that "few, if any, analysts believe that carried interest represents a return to capital rather than labor." Ultimately it all boils down to how you judge incentive fees. If you consider them as capital gains on risky investments and operations, such as buying out and restructuring a failing company then you are in favor of the current tax structure. On the contrary, if you see these incentive fees as solely payments in return for services rendered to clients, then you are a proponent for change.
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