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Private equity – still down but not out

Private equity is supposed to outperform its public counterpart, but the opposite was true for most of 2009. The best players continued nonetheless to demonstrate their entrepreneurial spirit.

By the fourth quarter of 2009, public equity markets had bounced back from crisis lows, but private equity remained in the doldrums. The players in this sector were not idly waiting for better times, however, but were in general making the most of adverse circumstances, in keeping with their entrepreneurial mind-set.

Public spat in top firm

Jon Moulton, the controversial head of private equity firm Alchemy Partners, which he founded in 1997, left the firm in early September with a vitriolic attack on the firm. He had already established a reputation for blunt criticisms of the industry of which he was part. He wrote to investors “With profound regret, Alchemy is not what it once was … the best solution is an early orderly planned termination …” He had planned to retire at 60, in 2010, but brought it forward, as he could not support the new head, Dominic Slade, who planned to take the firm into specialist investments in financial service buy-outs. Alchemy’s main specialisation had been in turning round troubled companies.

Moulton has given up plans to retire and has founded a new firm, Better Capital, which will be more focused on turnarounds. For him turnarounds have always been the best segment of private equity and he feels that they are very attractive. Many private equity operators are accused of being rapacious. It is refreshing to find an individual who displays candour concerning the shortcomings of his industry and focuses on the real value added by private equity operators, in improving companies rather than sophisticated financial engineering.

Bringing companies to market

The point of private equity activity is to buy companies, improve them and then sell them for a profit. Floating as an IPO is among the standard exit routes, and seems to be the main way available now, given problems with other forms of exiting, such as selling to industrial companies or to other private equity firms. The buoyancy of public equity markets, still alive in the autumn of 2009, offered the most promise. The motive for these potential IPOs is not just to return money to investors. About a fifth of private equity funds have less than a year to expiry and another third are due to mature within two years. To raise new money, a good record with the maturing fund is essential.

Many of the word’s largest funds, including Blackstone, KKR and Permira, are looking to use this route. KKR has already filed for the listing of a Singapore-based group Avago and Dollar General discount stores.

Seven of the top European buy-out firms are also actively considering flotations. Eleven IPO candidates are expected to come on to the market for more than $60bn. Many groups have been busy recently preparing their portfolio companies for flotation. What price they might get is another matter. Those companies that were bought at the top of the boom may not produce the outstanding returns demanded of private equity firms and could well underpin Boston Consulting Group’s estimate that 20-40 per cent of the largest private equity houses will disappear. Those hoping to bring companies to market need to pray fervently that the public equity market will not have turned down at the time, especially considering the above volume of deals in the pipeline.

Unusual alliances

Teaming up with trade buyers has been much talked about, but rarely acted upon. A recent example was when Bertelsmann and KKR entered into a joint venture to buy music catalogues. In September, CVC, Stagecoach and the Cosmen family combined to offer over $1bn for the UK’s public transport company, National Express.

The commercial logic arises from private equity funds having cash and industrial companies being starved of bank funding. A structural problem in this approach is that the industrial partner in the deal is looking for a long-term strategic acquisition while the private equity group needs to sell and move on in due course. In the Bertelsmann KKR case, a joint venture with the objective of more deals was the solution, while Stagecoach planned to take the bits of the company unwanted by CVC.

Bond markets to the rescue

Bank finance has run out, limiting leverage for private equity companies. This is reflected in the reduced number of deals. In the 12 months to October 2009, the top ten buy-out firms invested just $12bn, a tenth of the $120bn they laid out in the 12 months to August 2007, according to Financial News research based on Dealogic data.

Though bank finance has dried up, it is possible that the resurgence of the high-yield bond market might come to private equity’s rescue. Total issuance of these bonds was over $120bn in the year to 20 October 2009, three times more than one year previously. Financing deals with high-yield bonds have still not taken off, as banks are as yet reluctant to underwrite these issues. However, this development provides hope.

Avoiding distressed assets

During this crisis, there is no shortage of distressed assets for purchase, but private equity groups are by and large focusing on restructuring the companies they already have, in spite of the huge amount of cash they have to invest.

Mega-buy-outs defaulting

During the boom, mega-buy-outs were the order of the day. A Moody’s research study has found that the mega deals of 2005-07 have fared badly, with four out of ten having already defaulted, according to Moody’s Criteria.

Blackstone as hunter-gatherer

The giant private equity firm Blackstone is on the prowl to take over weak private equity and hedge fund managers still battered by the crisis. The group, which enjoyed a rebound in performance in all sectors in the third quarter, has $27bn of dry powder and $2bn of cash on their balance sheet.

Default worries continue

Many large private equity heads believe that investors will default on their existing commitments to provide money for private equity deals. Though this has been on the cards for some time, the belief is now stronger that quite a few of the limited-partner investors will be unable to meet their commitments.

Investors oppose bail-outs

Many companies acquired by buy-out firms are in trouble and need cash injections which their new owners cannot supply, as they are running out of money in the older funds. To solve this problem, they are attempting to raise annex funds from the same investors, but by and large investors are proving reluctant.

Cash still burning a hole

Private equity firms are still sitting on a huge cash pile that they have not got round to investing. According to IFSL, the private equity industry manages $2.5 trillion, a 15 per cent increase over 2007 because of strong inflow in the first half of 2008. About $1 trillion of this money, 40 per cent of the whole, is still in cash and the groups might have some explaining to do if the situation persists, given that they are charging investors 2 per cent per annum for managing this money.

Slight thaw amidst general gloom

Top buy-out firms are still keeping away from the market despite the stock market rally. In the world’s second-largest market, the UK, the number of buy-outs completed in the third quarter, at 31, is the lowest figure for 25 years, according to Nottingham University research. There are, however, signs that the groups are reverting to their roots in assisting troubled companies. The number of companies they have bought from receivership increased by 50 per cent in 2009 to 17, the highest number since 2001.

The global picture is a bit better, with the deals announced in the third quarter rising by 50 per cent compared with the second quarter, according to Dealogic.


* "Bonds return as debt pipeline runs dry", Toby Lewis, Financial News, 02.11.09
* "Buyout firms see signs of bounce-back", Toby Lewis, Financial News, 05.10.09
* "Firms struggle to ride the turnround carousel", Catherine Craig, Financial News, 21.09.09
* "Blackstone set to pounce on rivals hit by credit crisis", Martin Arnold, Financial Times, 07.11.09
* "Private equity industry is still on sidelines", Martin Arnold, Financial Times, 05.10.09
* "Pessimism in private equity’s top echelons", Martin Arnold, Financial Times, 23.09.09
* "Private equity", The Lex Column, Financial Times, 11.09.09
* "Private equity groups face investor opposition over bail-out cash calls", Martin Arnold, Financial Times, 01.09.09
* "Decade’s biggest buyouts have highest default rate", Peter Lattman, the Wall Street Journal, 06.11.09
* "Private-equity firms have funds available to invest", Oliver Smiddy, the Wall Street Journal, 19.08.09

By Dr Arjuna Sittampalam, Research Associate with EDHEC-Risk Institute and Editor, Investment Management Review

Lundi 3 Mai 2010

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