Investors must focus on margins in era of high rates, says Warburg Pincus boss

Higher interest rates have so fundamentally shifted the financial environment that investors must focus on a company’s ability to maintain margins rather than just its growth prospects, veteran private equity executive Chip Kaye said.

“This moment is different than anything we have had in the 40 years before . . . with inflation proving stickier and interest rates higher than currently expected — and more complicated great-power politics adding to that dynamic,” said Kaye, who started at Warburg Pincus in 1986 and has been its chief executive for two decades.

“If you could pick one characteristic of a business and that’s how you decide whether to invest, it would be pricing,” he told the Financial Times. “Lean into businesses that feel like they have the ability to adapt to a higher-inflation environment.”

Warburg Pincus is a traditional private equity firm with more than $80bn in assets under management that focused on growth investment. Unlike competitors that have sprawled into other areas and listed publicly, it is still a partnership.

Kaye said that when the firm looks at a potential investment’s product, whether in goods or services, it considers, “what are the alternatives, what is the ease of switching, and what is the contribution to the customer’s end-product?” Kaye said.

The flip side of that advice is that Kaye looks sceptically at lossmaking technology businesses that can no lower rely on free-flowing investor cash to subsidise their services. “When a $4 taco costs $1 to have it delivered, that’s one thing. When the $4 taco costs $8 with delivery, that’s different,” he said.

Chip Kaye: ‘We all misread the pandemic. We read it as a demand shock and it wasn’t really’ © Marco Bello/Bloomberg

Pricing power may vary depending on the situation. If something is a relatively small part of the overall cost, customers may not bother to switch suppliers if the price goes up.

It can also be controversial. Researchers at the University of Massachusetts suggested this year that some companies were using pandemic-era shortages to push up margins, dubbing the process “greedflation”, although groups such as Procter & Gamble have hit back.

Kaye argued that Warburg does not seek that kind of profit growth. Instead it works “with portfolio companies across every function to help drive efficiency . . . These steps ultimately deliver better value at lower cost and position companies for stable growth.”

Overall, he said, investors are having to come to terms with mistakes made in 2021 and earlier. “We all misread the pandemic. We read it as a demand shock and it wasn’t really — it was more a substitution of goods for services.”

“In today’s markets, we are seeing some of the consequences of that natural tendency to underappreciate risk when times are good,” he said.

“The investing environment will be more challenging — but the opportunity to differentiate should be exciting to investors.”


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