For readers of my blog, you know where I stand on the private equity industry. I have suggested for several years now that private equity activity would be entering a long slumber (see Private Equity: The End of an Era and Private Equity – Stupid Money Chasing Stupid Deals).

I was therefore interested to read an article that appeared in last week’s issue of the Economist claiming that private equity might be on the rebound (see The Barbarians are Coming, Again). According to the Economist:

As banks, which had been lending buy-out firms spectacular sums of money on extraordinarily generous terms, abruptly turned off their taps, buy-outs became a rarity. In the first half of 2009, just $24 billion of private-equity deals were completed worldwide and only three loans were extended to fund leveraged acquisitions, the lowest number since 1985, according to Dealogic. That compares with deal volumes of $131 billion last year and $528 billion in 2007.

MY COMMENT: Wow. A phenomenal decline! Those numbers are characteristic of an industry in utter free fall. With those kinds of numbers, it’s hard to see the rays of sunshine. But the Economist identifies several stylized facts that it believes are indicative of a recovery.

…several signs in recent weeks that the wind may be starting to blow in a better direction for private equity.

First, a few deals have been announced…Bankrate, a financial-services website, has agreed to be bought by Apax Partners for $571m.

There has also been a twitch of life in the market for disposals [exits from deals], with the announcement that Vitamin Shoppe, owned by private equity, intends to hold an initial public offering (IPO), albeit a tiny one that may value the retailer at $150m…Perhaps the exit market, which in the first half of this year has raised only $21 billion, compared with $115 billion in the first half of 2008 (according to Dealogic), is past its worst.

But the clearest signal that things are looking up for private equity is the news that the granddaddy of the industry, Kohlberg Kravis Roberts (KKR), is to revive its plans to go public—and fast.

MY COMMENT: Although private equity may be rising from the mat, I think it is a bit premature to use these events as de facto evidence of a revival. With respect to the first point about the recent uptick in deal-making activity, even including those recent deals, we are still on track for a greater than 50% decline in activity from 2008 to 2009. Moreover, there is no assurance that Apax’s $571m investment in Bankrate won’t suffer a similar fate as TPG’s recent $1.35B investment in Washington Mutual. As for the exit from Vitamin Shoppe, a $150m IPO might seem impressive, …had it not been for the fact that the private equity buyer paid in excess of $300m for the firm in 2002 (see DM News article). Finally, I am not surprised that KKR is trying to revive its previously delayed IPO. Wouldn’t you if you saw a 50% rally in the equity markets? They are acting perfectly rationally – trying to get while the getting is good.

The Economist continues:

For all its recent difficulties, private equity still has plenty going for it—not least an estimated $400 billion of uninvested capital. True, the credit-fuelled mega-deals of old are unlikely to return soon. Deals will be mostly financed with equity rather than debt, which means that private-equity groups will need to improve the fundamentals of the businesses they buy rather than just profiting from financial engineering.

MY COMMENT: The $400B pool of uninvested capital might seem like quite a war chest. But the fact of the matter is that even if 100% of those assets were put to work tomorrow, private equity activity would still fall some 20% short of that in 2007.

I agree with the sentiment expressed in the Economist that credit-fueled deals are a thing of the past. In fact, in March of 2008 I wrote:

…for me, these events officially mark the end of an era. We will likely look back at this period and eventually refer to it as the second LBO wave. In my opinion, there are now two identifiable, and distinct, LBO waves:

1. The 1980’s – the wave that most of us associate with the LBO heyday; driven by the break-up of conglomerates, culminating with the RJR Nabisco deal, and etched in our memories by the movie “Wall Street”
2. The 2000’s – the cheap money wave; fueled by excess leverage, cov-lite deals, financial engineering, and a dose of Sarbanes-Oxley compliance avoidance

I also agree that future deals will require much more equity than debt. But the Economist failed to identify what will likely become the largest draw of private equity investment in the coming years: distressed firms and assets. That’s where they will best be able to “improve the fundamentals of the businesses they buy”. Even so, we are many many years away from the next private equity heyday.

This entry was posted on Monday, August 3rd, 2009 at 4:00 am 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.