With the current economic landscape and this year’s presidential election not exactly giving it a good name, it’s been tough being a private equity firm.
Not helping matters is Republican presidential nominee Mitt Romney’s former private equity career at Bain Capital.
Michael Mauboussin: Challenges and Opportunities in Active Management And Using BAIT #MICUS
Michael Mauboussin's notes from his presentation at the 2020 Morningstar Investment Conference, held on September 16th and 17th. Q2 2020 hedge fund letters, conferences and more Michael Mauboussin: Challenges and Opportunities in Active Management Michael Mauboussin is Head of Consilient Research at Counterpoint Global in New York. Previously, he was Director of Research BlueMountain Capital, Read More
But I digress. Prior to the financial crisis, private equity was at the forefront of takeovers with cheap credit and eager investors. According to Dealogic, in 2007’s first half, the industry represented more than 18 percent of announced takeover volume worldwide. Today it’s a different story: in 2011, private equity was less than 7 percent of the total volume for global takeovers.
What the future holds for private equity remains questionable.
One of the many problems it is facing: too much money to invest, reported The New York Times. At the end of 2011, private equity firms had about $900 billion in “dry powder,” or money that they had raised prior to the financial crisis had idly been sitting, ready to be invested, according to Preqin. This won’t change anytime soon as it take around a decade thanks to the present takeover rates.
So what could speed this up? More deals? Maybe not since the current ones are pricey.
According to Bain Capital, in the first half of 2011’s private equity deals, multiples were approximately 8.5 times EBITDA; this may be compared to the multiples of 6 to 7 times at the last recession’s end.
Besides their high costs, deals have less sellers as they perceive the current market as underpriced. The competition has also risen for private equity firms from strategic buyers with their mountains of cash.
From this, private equity may be overpaying. A recent example includes the bidding war between Apollo Global Management LLC (NYSE:APO) and KSL Capital Partners for Great Wolf Resorts, Inc. (NASDAQ:WOLF); the indoor water park owner had lost money for five consecutive years.
And then there’s an up and down credit market. In March 2011, Del Monte Foods had been acquired with very low interest rates while now, the market has been pricey for leveraged buyouts.
Factor is selling as another problem for private equity firms. According to Bain Capital, it estimates that they have over 5,000 companies sitting in their portfolios ready to be sold, with companies valued at almost $2 trillion. In other words, the value of the companies waiting to be sold by private equity is greater than the money private equity has to invest.
Then there’s the exit route, ideally initial public offerings, which isn’t exactly a great venue this days (see Facebook’s IPO).
Private buyers have now emerged, like other private equity firms. Now approximately 25 percent private equity exits are “pass-the-baby sales,” according to Preqin. This means a private equity firm sells the company to another.
Returns have also decreased and fundraising isn’t as quick. They are difficult to find and review but many funds prior to financial crisis are either flat to up modestly; it’s not like the 20 percent to 30 percent returns in the past.
But last year, private equity did receive more on their investments than they did in the last four years added Bain.
So with all these challenges, what does this really say about private equity?
According to The New York Times, less credit has crushed the large buyouts seen prior to the financial crisis and moved large players such as Apollo Group Inc (NASDAQ:APOL) and KKR Financial Holdings LLC (NYSE:KFN). to make their deals in the middle market. From this, the small and medium players are nudged out.
No, the answer also doesn’t necessarily lie in foreign markets. European private equity markets have grounded to a halt with its short credit supply and lack of sellers negotiating. China, India and Brazil appear to be at the top of the lists for investing but it doesn’t come without challenges; India and China’s economies have lost steam and to invest there, local partners are necessary amid inconsistent profits.
As private equity becomes a tighter business, the larger firms have evolved into global alternative asset managers. The New York Timesreported that The Blackstone Group L.P. (NYSE:BX) gets additional revenue from nonprivate equity businesses while Apollo and K.K.R. have cut a deal to to manage the State of Texas’ alternative asset investments, such as debt and private equity.
And one area that appears to be the flavor of the month: activist shareholders. This includes Bill Ackman of Pershing Square Capital Management. By grabbing a big share of a public company and asking for change, it comes at a cheaper price. Dan Loeb of Third Point also demonstrated this with his recent successful activist campaign against Yahoo.
Private equity firms and their deals aren’t dead, they’re just going through a change. The pendulum will swing back with aggressive deals by firms and the stakes could be higher but with smaller deals.