Looking for Leverage with Private Equity
This might be an unsurprising fact, but the LBO (leveraged buyout) market is under significant distress. To put it simply, it is harder for Private Equity to support LBO activity without having the “L” due to a tighter credit market that is restricting lending and many buyout firms already supporting high leverage ratios with current investments from previously looser lending. Because of this, new deal flow has dropped precipitously (over 80% YOY according to Reuters) and many are calling for a complete shake up in the Private Equity industry. David Rubenstein from Carlyle Group mentioned this and more during his presentation to his industry colleagues at SuperReturn this year in Germany in addition to providing a 15 point plan to fix the systemic problems. (http://graphics8.nytimes.com/images/blogs/dealbook/superreturn2009/rubensteinsuper09.pdf). Time to write the epitaph and move on right? Well, nothing is always that simple.
First item to note is that money is still being committed to Private Equity. The mega firms, such as Apollo with its recently closed $15B VII fund, have still been able to draw on a significant amount of capital. I won’t say this luxury is available for all firms and some past limited partners may be adjusting future pledges if their portfolio value has dropped too much to skew their Private Equity contribution percentage above agreed thresholds. With all of this, new money is being committed. Secondly, deals are still out there, they just require a larger percentage of equity. Higher debt leverage provides greater return on the equity investment when valuation increases, but adding more equity lowers the ceiling potential and flattens the overall participating fund performance. This just means that the deals will be smaller and require a better eye for growth potential (the way it was before the 2005-07 boom). It is also possible to have an even greater focus on operational performance from those investments to help valuation as well. The last point to note regarding the continued importance of Private Equity is the new role they may play in the banking bailout. Carlyle is rumored to be setting up a $3B financial assets fund and many others will follow. Once the Treasury fully works out the public-private partnership structure, expect a significant amount of new activity. While has been stumbles into banking (TPG Capital and Wachovia), expect those issues to be addressed going forward.
The halcyon days from the recent boom may have passed, but Private Equity is here to stay in a new, leaner form. Infosys sees the importance of Private Equity and will continue to forge relationships with these industry leaders. Look for more on this topic in the weeks to come.
