End of cheap debt era brings sector to a standstill
By Martin Arnold, Private Equity Correspondent
Published: July 5 2009 09:01 | Last updated: July 5 2009 09:01
Two years ago, Henry Kravis, co-founder of Kohlberg Kravis Roberts, arguably the most venerable name in the 30-year history of leveraged buy-outs, declared it to be “the golden era of private equity”.
KKR had just filed for a New York initial public offering that would have helped Mr Kravis to keep pace with his fierce rival Stephen Schwarzman, co-founder of Blackstone, which had floated weeks earlier with a valuation of more than $30bn (£18bn, €21bn).
Yet the halcyon days for private equity – which had grown rapidly by using a sliver of its own investors’ cash and bucket loads of cheap bank debt to acquire some of the world’s biggest companies – were about to come to an abrupt end.
Since Blackstone’s IPOin June 2007, its shares have fallen by two-thirds. KKR has been forced to ditch its plans for a New York listing, opting instead for a less glamorous merger with its beleaguered Amsterdam-quoted vehicle.
One of the biggest headaches for the industry is that banks have stopped lending money for buy-outs. As the debt has dried up, so have the deals.
In addition, many private equity groups have suffered heavy mark-to-market writedowns on their portfolios of companies bought using record amounts of debt during the credit bubble.
As stock markets and the economy have gone into a tailspin, swathes of these companies are now worth less than their debt. With few signs of a recovery, it is doubtful whether their private equity owners will ever see a return on their money.
To make matters worse, the rapid growth of the buy-out industry has attracted greater scrutiny from regulators and politicians. Now it faces the risk of awkward legislation and higher taxes on both sides of the Atlantic.
At a dinner last month in London, David Rubenstein, co-founder of the Carlyle Group, said: “A few years ago investors were queuing up to throw money at us. So there was no pressure to explain what we were doing. Now we have to work much harder to get our message out there.”
Credit markets are unlikely to re-open any time soon for private equity. Banks are still nursing big losses and many are now part-owned by governments, whose priority is consumers and small business rather than leveraged buy-outs.
There is more trouble on the horizon for the buy-out bosses once dubbed “the masters of the universe”, as their investors are suffering badly.
Many investors, such as pension funds, endowments and insurers, deliberately over-committed during the boom, when cash flowed back fast from buy-outs. They are now struggling to meet these commitments as the flow of cash from deals dries up.
Some of these investors are reassessing their allocations to private equity. Many are shifting away from mega buy-out funds in favour of smaller funds specialising in small-cap buy-outs, distressed investments and emerging markets.
Others are pushing for better terms on fees charged by private equity. Joseph Dear, chief investment officer of the California Public Employees Retirement System (Calpers), the biggest US pension fund, called for “a better alignment of interest” between fund managers and investors at a Super Return conference in Geneva last month.
Calpers has increased its target allocation to private equity from 10 per cent to 14 per cent of its portfolio. But this is mainly to allow it to meet its existing commitments rather than make new ones, which Mr Dear said would be “very limited” this year.
Several investors have responded to their cash-crunch by seeking to sell chunks of their private equity portfolio on the secondary market, where second-hand private equity assets are traded, often at a large discount to their underlying value.
A recent survey of investors by Preqin, the research firm, found that 11 per cent of institutions planned to sell fund interests. It forecast that $75bn-$100bn of private equity assets could change hands, half in the next year.
Yet most investors believe the industry will continue to exist in some form. “We have some clients who are above their allocation to private equity, as other parts of their portfolio have fallen faster than their private equity investments, so they are pausing for breath,” says Jane Welsh, senior investment consultant at Watson Wyatt. “But there are other clients who are new to private equity and see this as an interesting time to start a programme.”
Critics of private equity have long argued that the high returns the best buy-out groups have achieved for their investors – well above those from stock market indices – are almost entirely due to the extra debt they use to acquire companies.
Now there is ample evidence that debt can also multiply returns on the downside, investors are looking for private equity groups that can find a way to achieve outsized returns without relying so heavily on financial engineering.
Copyright The Financial Times Limited 2009 |
