Opinion about Private Equity from Seeking Alpha full article at link.
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A diamond is forever even if it spends years in a drawer only to periodically emerge for moments of brilliance. Business cycles continue but the existence/relevance of private equity should not be doubted. This downturn will pass and private equity will come roaring back with the largest war chest it has ever possessed and more brazen tactics. This will pass, and it seems like many institutional investors agree, as they continue to pour money into all the new mega-funds the PE firms are closing each passing day. Alison Mass, co-head of Goldman Sachs’ (GS) financial sponsors group, speaking at the 20th Annual Buyouts East conference last week in New York, had this to say, "Private equity is not a new business." She went on to say that, "It consists of firms that have been in business for decades. But it’s a cyclical business. [They] have seen these cycles before."Indeed, some of the best returns the industry has recorded came from down years, she said. In the downturn from 2000 to 2002, the best-performing firms generated annualized compound return rates of more than 10%, according to Mass (This seems to fit with The Prince’s suggestion to buy when there is blood in the streets).
Mass also saw equity checks continuing to rise in the current turmoil in the market. However, she emphasized that this is a trend that has been underway for quite some time. She provided the example of KKR’s takeover of Safeway Stores in the late 1980s which was a $5bn buyout with only $130m in equity from KKR. Today 30-35% equity is assumed for most buyouts even at the peak of the buyout book last spring. Mass said that percentage could rise to as high as 50%. This will obviously dampen returns for private equity firms since the impact of lower leverage will be lower returns. Remember that there are essentially three ways to make money in an LBO. First, the PE shop can improve operating performance by improving margins through rising revenues and/or cutting costs. This would serve to improve the EBITDA of a company that has been taken private by a PE firm. The second strategy is to depend on multiple expansion, that is, buy companies in industries that are out of favor, at low multiples, and resell them when the industry cycle hits its peak for a higher multiple. The final way to make money in an LBO is through leverage. The best firms employ all three strategies effectively but some firms specialize in one in particular.
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