Paris Innovation Review. Let's start with the current state of affairs. What is your view of the situation in Greece?
Dominique Sénéquier: I think everyone has over-focused on Greece. Greece is a very small economy in the eurozone; it is only 2% of the eurozone. It’s a $300 billion economy, which is rather small. It is clear that people have already written down the debts of Greece maybe by 80% to 85% or more. It’s a social problem because it could have been a default. To avoid a default, Brussels has asked Greece to make a lot of sacrifices in terms of age of retirement, decreasing salaries of civil servants…. There has been a lot of publicity around this.
Greece may have avoided a default for now but do you think the situation will continue, and what might be the implications for other European countries?
I think the example of Greece is extreme. I would say the only country which may be close, but even smaller in terms of its economy, is Portugal. Portugal is a $240 billion economy. It’s two-thirds of Greece. So, eventually, even if Greece and Portugal have problems, it won’t change the life of the eurozone.
What do you think of the situation in Italy and Spain?
It’s very, very different. If you speak about Spain, the debt to GDP [ratio] is not as high as other countries. In Spain, the problem is not the government and not the debts of the government. The problem is the banking system. Now Spain is cleaning up the banking system. Some of the banks are merging. So I’m not afraid at all about Spain.
Italy is a different issue. Italy is the fourth major economy in the eurozone. It is $2.2 trillion, so it’s just after France. The economy is nearly as large as the U.K. People don’t understand that. They believe the U.K. is a very large -- or very important -- country in Europe. In fact the GDP of Italy is $2.2 trillion and the GDP of the U.K. is $2.5 trillion. For Italy, the problem was also that the tax system was not efficient and certainly too small. I mean the tax pressure was too small.
I wonder if you could speak a little about what you think of the U.K.’s and [U.K. Prime Minister David] Cameron’s response to the eurozone crisis and what’s going on.
Part of the direction of Cameron is certainly more political than economic. His party has never been in favor of Europe and in favor of the centralization of the regulation in Brussels. So it is a political argument between the eurozone and the U.K. about liberal markets, the liberal philosophy and the philosophy of the eurozone, which is certainly led by the Germans and the French.
Based on everything you’ve said, do you believe that the eurozone will either break up or should be broken up?
No, I don’t think it will [break up]. This crisis will hasten the tie between major countries like Italy, Germany and France. There will be more harmony in terms of tax. There will be more budget discipline. And reforms that would have taken 20 years to achieve [otherwise] will be done.
Now if you were to turn to the U.S., the job situation here seems to be improving. There are also some signs of a manufacturing revival. I wonder if you could share your analysis of both the strengths and the continuing risks in the U.S. economy. And what are some of the implications for private equity investors?
I think the U.S. has a lot of debt. When we speak about the problem of debt, it is clear that the U.S. has much more public debt than the eurozone in term of volume. But the dollar is the reference currency because the euro is a young currency. So it is easier for people to lend to the U.S. And it is very easy for the U.S. to borrow. You can print money. You can sell U.S. treasuries. When we see the volumes that the Japanese and the Chinese have of U.S. treasuries, it is enormous. I think it is $5 trillion or something like that. So, for the time being, I don’t see any problems for the U.S.
In private equity, portfolios - despite a tough time during the crisis - have recently outperformed many public markets to the surprise of many observers. Big challenges certainly remain in Europe and in the U.S. But how is private equity likely to measure up against public markets over the next few years?
It is a little difficult. If we look at the past, it’s clear that the private equity index has always over-performed the Dow Jones and the S&P. If I look at 25 years, the private equity index has been 12.6% and the Dow Jones 10.4%. And if we look at three years, it’s 7.3% for the private equity index and 3.2% for the Dow Jones. The only problem is that if we look at Europe the markets are still very low compared to what they were in 2007. They are like minus 50%. The U.S. is minus 14%. So if there is a strong recovery in the markets in Europe, they would outperform the private equity portfolios. In the U.S., the private equity portfolios should outperform the growth of the stock exchange because the stock exchange has already recovered.
The private equity markets will over-perform in any case over long-term periods, like 10 years, for many reasons. First, in private equity funds you have majority stakes in companies, not minority. It means that there is one shareholder with control. And this shareholder is very intense, demanding a lot to the management. Also, the management is aligned with the interest of the private equity funds. It is a different kind of corporate governance.
You mentioned a five-year timeframe where debt can bounce back. In that time, if PE firms are to make returns without debt, do you find yourself and the PE business focusing on certain industries, which are possibly more asset heavy, which allow easier access to debt?
No. In our philosophy of private equity, we are first focused on the quality of managers. We have always thought that the first values in the company are the human values -- the people. [This is] independent of the business. So that will be our first criteria of acquisition of the company. I don’t think we will select a specific sector. We will always keep the same philosophy which is focusing on the best managers. And then we need to have a business which can face the competition of the e-commerce. This is a major threat: Borders went bankrupt because it totally lost the ground with Amazon and e-books. For me, it will be the main threat in the next 10 years, much more important than factory or no factory, and energy.
To extend that question, will holding periods for companies change? Will the three-five year exit period just be a pipedream? Will holding periods be longer, even for private equity?
Well, I think very few people said three-five years. As far as I know, most people have always said five-seven. In the case of KKR [Kohlberg Kravis Roberts] it is even longer. And they are one of the best. So we’ll keep to five-seven.
In a recent interview with Paris Innovation review, you had talked about how you won’t allocate 50% of your fund to, say, China or Brazil or something because emerging markets, while they provide an opportunity, are still not up to the level of Western companies. Do you find yourself as well as other firms having to change the model in the next five years to tap into these emerging markets because check sizes and deals might be smaller? And the second part of that question is: if not, do you find yourself looking to these geographies for portfolio development of the companies that you buy in the West?
Absolutely. First, it’s totally true that we develop our European companies in India and China through joint ventures, through plants, through build-ups. It’s key for us. We do it also in the Middle East. That is very important in terms of diversification.
We opened a Singapore office to cover Asia in 2005. We are opening Beijing this year. And we are just reaching maybe 10% of our assets under management in Asia. So my goal is to go slowly. We have a lot of connections in China and also in India and Indonesia. But we need to go slowly because the legal environment is very new for us and is not the same as in Europe and the U.S. So we need to be more careful than in countries where we have been working for the past 20 years. It’s part of finance to go slowly when you are beginning a new activity. It’s like a new activity because you need to know all the people. It’s a different network. It’s a different culture. It’s very interesting and you can be successful. We are successful in our activities. But we have been what I call very conservative.
Do you find yourself having to change business models of deal size, especially with the lack of buyouts in markets like India and the need for private equity investors to get comfortable with less than 50% equity ownership in companies? How do you get comfortable with that?
India and China are not countries for buyouts. They are countries for growth, expansion or minority stakes, but not for buyouts. In fact there are not many countries where there is buyout activity. Even Japan is not a country for buyouts. So what we do in India and China -- but mostly in China because India is more difficult than China -- is buy minority stakes. Most of the time we do it alongside private equity funds where we are Limited Partners and where we know the managers very well.
What currency will these deployments be in? How do you hedge the currency risk?
In the past one year, some emerging markets currencies have depreciated by over 10%, which is quite significant. It’s a big problem for India. It’s very, very costly. We had one investment on which we are losing money on the currency because it was too hard to buy a hedge. In China, most of the investments are done in dollars.
Given all the political commentary on private equity in the U.S. of late, will you find the LPs such as pension funds or endowment funds changing their allocations to the private equity class in the next two, three years?
I think it won’t hurt the allocation of the pension fund industry towards private equity.
AXA is a patron of ParisTech Review. This interview was realized in partnership with Knowledge@Wharton, whom we wish to thank for taking the biggest load of the work. It was first published by Knowledge@Wharton on April 6th 2012 under the title Dominique Senequier: Private Equity Portfolios Should Outperform Stocks in the U.S..