Several months ago (in April to be precise) I blogged about what I saw as the profligate investment ways of private equity firms – acquiring everything in sight at eye-popping multiples (see here and here and here for background). At the time, I argued that as credit contracted due to the repricing of risk, default rates would rise and result in an increase in the rate of business failure. I saw private equity acquisitions as especially vulnerable given that they were “overpaying” for targets and burdening the individual businesses in their portfolios with massive amounts of debt.

Well, it looks like some of these problems are finally coming to roost.

In an interesting article published today in the Wall Street Journal online (see Chrysler Loan Sale Likely Postponed, hat tip CalculatedRisk), Dana Cimilluca discusses some of the difficulties that Cerberus has been having selling Chrysler’s debt.

What does this article have to do with the more general, systematic collapse of recent private equity acquisitions?

Although the article is focused on one specific case (Cerberus and Chrysler), the last paragraph summarizes the process by which deals of this type go bad and some of the larger problems endemic to private equity purchases over the last few years. The article states:

Chrysler’s woes are the latest setback for Cerberus, which went on a buying binge early in the year when the credit markets were booming. Now it faces a rough road at Chrysler and the GMAC auto-finance business it bought from General Motors last year, not to mention its effort to walk away from its pending buyout of United Rentals.

First, the article aptly describes actions of private equity players as “binge buying”, indicative of a bubble. Second, the article discusses effects that are consistent with the backside of such a binge/bubble – credit dries up leaving credit commitments unfunded forcing private equity buyers to look for a way to back out of the deal (as with United Rentals) or causing temporary bridge financing to convert long-term pier financing (as with Chysler). Finally, the article discusses what happens on the backside of a deal gone bad – the “rough road” that Cerberus faces after an ill-advised purchase (as with Rescap, which faces insolvency).

I would expect to see more of these kinds of effects over the next year or so as more and more private equity deals start to go bad. At the beginning of this cycle we will generally hear (as we have) about firms trying to back out of their deals. Toward the end of the cycle, we will hear more about default, insolvency, and eventually, bankruptcy.

The market for private equity activity (and M&A activity in general) is clearly on the decline. Let’s hope that the damage isn’t too great, but at the very least, it’s clear that it will be tough going for the next year or more…

This entry was posted on Monday, November 19th, 2007 at 6:59 pm and is filed under Corporate Strategy. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.