File this one under Nothing Wall Street invents is working.
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Harry Newton / April 16, 2009
insearchoftheperfectinvestment.com
"I own a little of the Goldman Sachs Vintage Fund IV. It's a private equity fund made up of discounted slivers of other people's funds. The idea was that buying private equity at a huge discount -- because someone or some institution needed desperately to sell -- gave huge returns in the long-term.
My December 31, 2008 account shows I'm down only 4% on the year. But Goldman says when they finally figure it out, I should be down an additional 13% to 18%. So maybe 22%. That's their "best estimate." They explain:
Private equity has clearly been affected by this challenging environment. By the fourth quarter of 2008, acquisition financing was essentially unavailable, which led to a dramatic slowdown in new deal activity. Additionally, exit alternatives were severely limited as the public markets were essentially closed for initial public offerings an both financial buyers and strategic buyers were more inwardly focused and generally unwilling to consider acquisitions. Lastly, it has become increasingly clear that the economic downturn has directly or indirectly affected the performance of nearly every portfolio company.
Global M&A (mergers and acquisitions) volume fell more than 29% in 2008, to $2.9 trillion, from record high volumes in 2007. In addition to contributing to the reduced aggregate level of activity, the lack of available financing disproportionately affected sponsor-backed activity. As a result, private equity's share of global M&A declined from a 2006 high of 19% to just 4% in 2008. On a dollar volume basis, leveraged buyout (LBO) activity was the lowest since 2003. As in previous years, public to private transactions accounted for a significant portion of that LBO activity, 66% by transaction value. From 2004 through 2007 recapitalizations of companies owned by private equity funds exceeded $20 billion annually, generating significant dividend payments for funds and their LP's (limited partners, like me). That source of proceeds evaporated in 2008, with just $1 billion in recapitalizations; there were no recapitalizations in the second half of 2008.
The dislocation of the global credit markets which began in the second half of 2007 led to severe de-leveraging (paying off debt) across the leveraged finance investor base. This de-leveraging, combined with an "overhang" of transactions to which private equity firms and banks had made financing commitments (the leveraged loan forward calendar peaked at $237 billion), created a massive technical imbalance in which demand for capital far outstripped the overall supply. These technical issues were exacerbated by relative value pressures in the investment grade, loan and high yield markets. As a result, from record-setting volume in 2007, leveraged loan volumes fell by 71%, to $155 billion; high yield issuance fell by roughly the same percentage. This was a trend that had begun at the end of 2007, with volume in the second half of 2007 down 57% from the first half of the year. Private equity-related leveraged loan volume fell by 98%. In 2008, pricing moved up just as dramatically as volume moved down, with leveraged loan spreads ballooning 812 bps (basis points) to 1,122 bps.
After peaking in 2007, valuations for private equity began to decline as the credit which facilitated lofty valuations dried up and as falling public equities created downward pressure on valuations. On average during the year, buyout firms paid 9.5x trailing EBITDA for companies with EBITDA over $50 million, down from 9.8x in 2007. By the second half of 2008 valuations has dropped further to 9.1x, but with few transactions taking place that number likely understates the extent to which valuations have adjusted downward. There is widespread agreement in the private equity industry that values will continue to fall and that those participants with fresh capital are eager to invest at valuations that reflect the new valuation environment, the uncertain economic times we are experiencing as well as the limited supply of debt capital. Deal size also changed dramatically in 2008. The largest LBO (leveraged buyout) of 2007, TXU, was $44 billion whereas the ten largest buyouts announced in 2008, combined, were valued at $35 billion.
While venture capital funds were buoyed by a strong IPO market in 2007, that market was virtually shutdown in 2008 making it a difficult year for venture capitalists as many planned public exits were postponed. There were 6 venture-backed IPOs in the U.S. in 2008-the lowest since 1977-raising $0.5 billion, down from 86 IPOs raising $10.3 billion in 2007. In fact, there has only been one venture-backed exit in the last three quarters. In 2008 venture-capital investing declined for the first time since 2003, down 8% from 2007; the number of deals dropped as well, by 4%. Clean Technology was the one significant growth area for venture capitalists, representing seven of the ten largest venture-backed investments, increasing by 52% in dollar volume.
After a second record setting year in 2007, private equity fundraising declined to $465 billion in commitments, down 6% from 2007. The fundraising environments has, however, changed more dramatically that those figures suggest. Quarterly data tells a more complete story of the magnitude of the change; fourth quarter 2008 commitments were down 66% from the first quarter. In addition to the slowing pace of commitments, in an unprecedented move, a number of major funds have allowed their LP's to scale back their existing commitments.
The broader economic and financing environments have had profound impacts on private equity managers and their portfolios. General partners recognize their portfolio companies need to be prepared for an extended downturn and are working closely with their management teams to aggressively manage costs while closely monitoring liquidity needs. As weaker participants in each industry falter, general partners are trying to position their companies as the survivors and future winners although it is unclear when the market environment will again be conducive to growth. While there are instances where underlying portfolio companies are able to take "offensive" (rather than "defensive") actions such as making acquisitions, such activity is more the aberration than the norm. Generally speaking, private equity investors recognize this is a time for their companies to survive rather than take meaningful operating risk and are instructing their managers to act accordingly.
All this is nothing new. It's just depressing when you see your miserable investments with Goldman and see their employees getting $10 billion or so in bonuses. For what? For losing me money?" |
