When it comes to leverage multiples, six is the new nine
In order to complete an LBO , private equity firms need access to debt financing. But, wiht banks going through a process of deleveraging, there is less chance for PE firms to find necessary credit. Says one PE pro “With less leverage available, we expect to see a downward adjustment in pricing, leading to lower entry valuations that private equity firms pay for portfolio companies.”
2. Quality of portfolio companies in doubt
Worries about the credit quality of existing portfolio companies. The combination of high levels of leverage and an impending recession in North America is creating a building wave of corporate defaults, many of which are portfolio companies of buyout funds.
3. Less leverage used in new deals:
After increasing every year since 2002, the average debt multiple of large corporate LBO loans dropped from 6.9x for 2007 (when the market peaked), to 4.9x for the first half of 2008 (but still higher than the low leverage years of 1998-2003).
With the credit crisis, we are seeing that the cost of leveraging is increasing, maybe even doubled.
Table of Contents:
Some good news...
1. lower valuation expectations
As a result of the recent financial crisis 2007/08, we see that valuation expectations are coming down of firms looking to go private (VC or PE money in). With lower valuation expectations, there are more deals that can get done.
2. Distressed firms = buying opportunity
Firms that have money to spend should find more opportunities to purchase struggling firms in this market. The dwindling availability of debt to support acquisitions, the increasing threat of recession in the U.S. and the resulting turmoil in the public equity markets has dramatically impacted global mergers and acquisitions activity.
3. Emerging markets opportunities
Because emerging market PE deals typically use less leveraging (less debt), there are still many deals in emerging markets that can be done. This is in stark comparison to the US market (as of Sept '08) where leveraged buyouts market has fallen flat.
Trends Driving Mid-market PE activity (2008)
Change in rules for PE in Banking sector:
In response to the credit crisis, there has been a change in rules regulating Private equity in the banking sector. The fed loosened the rules. It was 25% if a private equity firm wanted to buy into a bank, that was the limit. If you owned more than 25%, you were essentially regulated like a bank. But, they changed the rules to 35% in an effort to bring the PE "smart-money" in from the sidelines, and to have the wealth of PE funds help get the US banking sector through this crisis.
But will PE firms jump in? Maybe not. Largely because 35% still is not a controlling interest of 51% like many PE firms want when considering highly risky deals.
On the other hand, PE firms looking for opportunities from the crisis, will likely look to the "Paulson Plan"...there may be rush of funds looking to buy up "toxic debt" 10 cents on the dollar, and then try to make money off of those assets (finding the good from the bad).
Secondary market expanding:
More than $30 billion was spent last year in the secondary markets, and the sector is expected to increase to $45 million in 2009.
Increased focus on Middle market deals:
see also mid-market private equity
The tightening of the credit markets and the resulting sharp decline in high-leverage megadeals has generated strong interest in middle-market transactions -- a trend that is expected to continue at least throughout 2008. Middle-market transactions are projected to remain in focus because they do not depend on syndicated debt, according to PricewaterhouseCoopers' transaction services group's midyear mergers and acquisitions forecast for 2008. In addition, three regulatory factors may drive an increase in middle-market deals -- and possibly all deals -- before year's end.
Accounting Changes
Mark-to-Market (or "Fair value accounting")
New accounting rules will change the way accountants record the value of companies. Rather than using the "historical" cost on the Balance Sheets, there are new rules that assets must be valued as if they would be sold today ("marked to market")
Impact on the Private Equity industry: The private equity industry is going to be hit by volatility in accounting for their assets, as newly adopted rules force them to mark down the value of their portfolios, high profile private equity bosses cautioned on Tuesday. Mark-to-market, or "fair value" accounting, took full effect this year, requiring companies to value assets at current comparable prices. The rules are known as FAS 157, which defines how companies should use fair value, and FAS 159 which lets companies elect to use fair value for certain assets and liabilities. "In many instances the LBO funds are going to be forced to mark assets to market for first time," said Thomas H. Lee, president of Lee Equity Partners, a $7 billion hedge and leveraged buyout (LBO) firm. "Many haven't done this in the past." "It will be brave new world out there," Lee, who left the buyout firm that bears his name, Thomas H. Lee Partners, in 2006. "Just as we see mark downs we will see mark ups. So the class itself will be very volatile." read more from: Reuters 06/03/2008
Note: after the credit crisis this rule might be changed again!
Capital Gains Tax change effects Private Equity & VC
6-2008: “Capital gains taxes are going up no matter who gets elected president, or what party they’re from. That’s just how it’s going to be.” Those were the words back in January of one of this space’s better sources – an ardent Republican who had not yet decided who to support in his state’s GOP primary. Our conversation was more about politics than business, but his point is beginning to significantly impact the private equity markets. Specifically, lots of people are looking to sell their businesses now rather than in 2008 or 2009, in order to avoid paying what they believe will be higher capital gains rates.
This philosophy is most prominently felt in the small-cap and mid-cap buyouts spaces, particularly when it comes to buying family-owned businesses. It’s also having an impact among VC-backed entrepreneurs.
It seems to be counterintuitive, given that company values are depressed across the board. Apparently the calculation is that the value lost by selling today is less than the return lost by paying on a higher capital gains rate in 2009 or 2010. This is particularly true among those who aren’t expecting an economic rebound anytime soon.
Interesting argument to watch develop, particularly as investment bankers promote it to attract new clients…
source: PE Hub blog
Venture Capital Trends:
see our VC trends here
No exits after the credit crunch?
In 2008, we see a sharp reduction in VC exits: for the first time in 38 years, the quarter had ended in the U.S. stock marketwithout a single venture capital-backed IPO.
Private Equity shifts focus
Dow Jones Private Equity Analyst released a study that shows private-equity fundraising for the first quarter of 2008 is up 32% over the first quarter of 2007 -- arguably the industry's peak. What the sector is seeing, however, is a shift toward other alternative assets. From the chart below (courtesy Private Equity Analyst), it is apparent that while fundraising for straight leveraged buyouts has diminished, areas such as mezzanine, distressed debt, venture capital and more diverse fund-of-funds have grown to more than compensate. While private-equity firms are stocking up on cash, they are also branching out to employ different investment strategies (funding reverse mergers and PIPEs -- private investments in public equity), exploring new industries (TPG's investment in Washington Mutual -- see Deals) and implementing more robust operational improvements at portfolio companies (sector consolidation and strategic acquisitions made by portfolio companies).
source: www.broadgate.com.
Interesting Trend: Private firms keep publishing public financial data:
Traditionally, private companies disclosed far less about performance and operations than their public counterparts. This was more evident in private investment houses, which operated almost as clandestine services. Even after Depression-era legislation introduced many reforms on the ways securities firms operated, they remained opaque institutions to most outsiders
But in a post-Bear Stearns era, when counter-party risk is on the mind of every risk manager worth his paycheck, opacity can be a serious handicap for a securities firm. Shareholder behavior provides important signaling for counter-parties about the financial health of a firm, while financial disclosure regulations force firms to divulge sometimes inconvenient truths about their performance. A sudden drop in a firm's share price can signal to counterparties that shareholders have detected problems, for example. If Lehman were to attempt to use a management buyout to "go dark," relieving itself of the burdens of public disclosure, Sarbanes-Oxley compliance and the like, it could very well trigger the kind of flight of the counterparties ;the equivalent of a run on the bank that crippled Bear Stearns.
It seems far more likely that Lehman would borrow a page from private equity firms, going private with debt financing that requires registration under securities laws and carries with it stringent reporting requirements. Sarbanes-Oxley is often presented as the bane of corporate executives but for Lehman, its accounting demands could play the vital role of assuring counter-parties that Lehman is safe to do business with even without the oversight of public shareholders.
source:John Carney, editor of DealBreaker.com.
Fund-raising:
see
private equity fund raising
More trends
PE returns return
Long-term private-equity returns for the U.K. market rose in 2007, passing the stock market and pension funds. PE buyout firms made an average of 20.1% for the decade through 2007. Figures, however, are still below the expected average of 25% to 30% per year. Reuters (05/19)
Green investing declines
Private-equity firms have increased investments in the green sector, but the credit crunch is forcing these firms to pull back on some of their investments. The firms are encouraging portfolio companies to improve efficiency and reduce waste, but they are leaving new investments, like in the alternative energy sector, to venture-capital firms instead. Wall Street Journal/Dow Jones Newswires (05/19)
Funds in emerging markets hit record
The prospect of investing in emerging markets raised $25 billion in the first four months of the year, setting a course that should top last year's figures. Fundraising for 2008 is predicted to reach $75 billion, compared with the 2007 total of $59 billion. Reuters (05/15)
Private equity heads abroad seeking deals: The financial slump in the U.S. is prompting buyout firms to invest more of their capital overseas. According to Thomson Reuters data, more than half of the takeovers announced by U.S. private-equity firms so far in 2008 involved foreign targets. Reuters (08/2--8)
Emerging Markets set up their own Private Equity funds:
China plans own private-equity fund: China's national pension fund is planning to set up a specific private-equity vehicle worth about $730 million. The pension fund actually received approval to branch into private equity earlier in the year and hopes to have nearly $15 billion invested in buyouts by 2010. Google/AFP (8/27/08)
More Limited Partners than ever before:
Currently there are about 3,800 LPs in private equity, a dramatic increase from 10 years ago, when there were only about 50 LPs investing.
Good times for Private equity firms:
According to data provider Preqin, it is estimated that private-equity firms will bring in close to $9 billion from management fees charged on open funds for 2008. Together, buyout firms have about $450 billion committed to their funds that has yet to be used. With the average industry returns reaching about 25% for the past few years, investors are still looking to get onboard the private-equity bandwagon. Intesa Trade (09/08/2008)
Effects of the Credit Crunch
see also our discussion on "decoupling theory"
Oppportunities:
Stong backlash as result of the credit crunch has created a growing sector that's attracting private equity. As regulators seek to keep closer tabs on banks' activities and their overall risk, the firms that provide risk-management and compliance services are finding themselves in high demand. Carlyle has been quick to the plate and has partnered with Kennet Partners to expand their holdings in the financial-services industry -- starting with FRSGlobal.
1. Calls for more regulations/ more transparency:
"U.K. buyout firms have less than one year to increase their transparency or face legislation. Private-equity firms need to connect with the outside world and are being asked to provide business reviews similar to those that public companies release. Reuters (04/08)"
More threats for private equity: The Treasury Department's proposal for regulating the financial market poses more threats for private-equity firms. It calls for more involvement from the Federal Reserve, gives the central bank extra visibility into firms' investments and even gives the Fed the power to force buyout firms to address financial-stability problems. Chicago Tribune (04/01) see more: private equity trends
2. Companies try to get out of deals:
"Goldman Sachs Group is the latest private-equity firm to back out of a takeover in light of the worsening economy. The $794 million agreement to acquire Myers Industries, an international manufacturer of plastic products, was expected to close in third quarter of last year. Wall Street Journal/Dow Jones Newswires (04/04)"
2. less "leverage" being used to fund deals:
"Private-equity firms are now required to put more down for investments. There was a time when private-equity firms hardly supplied 10% of the value of an investment, borrowing the other 90% from banks. Now buyout firms are putting up as much as half of the company's worth to complete a transaction. Reuters (04/07
3. no effect?
"PE strategies usually call for holding investment assets for three to five years, thus economic downturns for these investments are expected, in other words, business as usual for private equity. AccountancyAge (04/03)
4. other changes:
The credit crisis of 2007 has had its impact on Private equity.. Not only are fewer M&A deals taking place, but private equity's share has dropped. Last year, private-equity-backed buyouts accounted for 19.2% of the M&A deals. The start of this year has seen just a 7.9% involvement in the transactions.
M&A deals fall for January
Global M&A fell to its lowest volume for January in three years. Combined values for last month totaled $164 billion, lower than the previous record set in November 2004. The global economy, bank losses and the health of the capital market have all taken their toll on the worldwide deals. MarketWatch/Dow Jones Newswires (02/04)
Feb 2008:
The credit crunch continues to make it nearly impossible for private investors to borrow money, particularly for the megadeals that drove the meteoric growth of private equity over the past few years. However, based on a recently released report from Private Equity Intelligence, the future of private-equity investments may not be so dismal. The report suggests that total assets for private-equity funds will grow from $2 trillion in 2007 to $5 trillion in seven years. If this occurs, private-equity assets will still make up only about 3% of the total global market cap, leaving the industry with ample room for growth.
Future of private equity looking rosy
Even with the clench of the credit crunch still holding strong, private-equity researchers say they believe that the future of private equity may not be so tight. Private Equity Intelligence has predicted that the total value of assets run by private-equity funds will reach $5 trillion in seven years. The Business (02/13)
Opportunity: "Troubled Debt" buy backs:
Private-equity firms are teaming up with hedge funds to buy "troubled debt." The abundance of cheap debt and expected returns of at least 20% have fueled this new tag-team trend. New York Post (05/01)
4. Effect on Investment Banks (negative)
Deal-making activity has all but collapsed since the start of the credit crunch in June 2007. As a result, this has significantly reduced the fees that investment banks once collected from private-equity firms during a healthier economy. Wall Street Journal/Deal Journal (03/31)
Looking for opportunities after the credit crunch....
Bain Capital raises $20 billion
Bain Capital is set to close a $20 billion global buyout fund, indicating the firm is gearing up for the upcoming deal-making season. The company hopes to capitalize on opportunities that may come up after the credit crisis. Financial News (01/31)
PE "bolt-ons" on the rise
Bolt-on acquisitions, a phrase used when private-equity firms buy smaller companies and add them to bigger companies they already own, are on a steady rise. 2007 saw a 13.5% increase in these types of acquisitions compared with 2006. The Wall Street Journal (03/05)
Private Equity Investments in Infrastructure
Fundraising this week was dominated by infrastructure funds, with two firms raking in nearly $10 billion. Global Infrastructure Partners closed its first fund with $5.6 billion. Morgan Stanley closed its infrastructure fund with $4 billion locked up. The funds will focus on transportation, energy and utilities, social infrastructure and communications. Global Infrastructure Partners, just two years old, has already invested in the London City Airport, International Port Holdings and East India Petroleum.
The resilience of infrastructure businesses has attracted private-equity players to the category, despite slower growth than traditional private-equity investments. Other new infrastructure vehicles include Goldman Sachs' $7.5 billion fund, 3i's $1.2 billion India Infrastructure Fund and a $950 million fund for Credit Agricole Private Equity, as well as Citigroup's $5 billion infrastructure fund and Macquarie Capital Group Ltd. and State Bank of India's recently unveiled $2 billion infrastructure fund, both of which are yet to complete fundraising.
Older News & trends:
SWF's: Code of Conduct
Due to fears about the potential for wrong-doing (as a result of a lack of transparency), there have been many calls for an international code of conduct among SWF's :
Sovereign-wealth fund code of conduct
The International Monetary Fund will establish initial guidelines for SWFs' code of conduct in October. The new guidelines will be geared at squashing concerns about the size and influence these funds have in the market. BBC (05/02)
A slow down in the US leads to PE growth in Asia?
Asian private equity
The past year's rocky Western economy has fueled activity in the Asian private-equity market. Funds under management saw a 14% increase from last year's numbers, and investments rose 33% from last year's figures as well. Reuters (01/18)
Slowdown in the UK
Buyout market slowing in Britain
Private-equity firms are predicting a slowdown in the U.K. economy and say that the region is becoming less attractive as a place to do business. Seventy percent of the firms polled said they expected the U.K. economic environment to worsen over the next 12 months, according to the British Private Equity & Venture Capital Association. Reuters (01/17)
Slowdown in Canada (caused by the US credit crunch)
North of the border, however, Canada won't be setting records any time soon. Private-equity buyouts totaled $2.3 billion for the last quarter of 2007, an increase from the $1.4 billion figure a year earlier. Despite the increase, investors feel the composition of the deals will take a downturn. "Megadeals," like last year's BCE deal, have all but dried up, leaving the industry to rely only on the small and mid-size buyout transactions to drive activity.
Canadian megadeals dry up
Canadian private-equity buyouts peaked at $2.3 billion in the fourth quarter of 2007, up from $1.4 billion a year earlier. But the global credit crunch, which began last summer, has driven 2008 into what appears to be a dry spell of major buyouts. The Globe and Mail (02/13) (Subscription required)
Golden era of private equity is over
The past five years have been golden for private equity, but the future does not look as promising. Merger activity has taken a downward slope, and recovery will depend mostly on the credit market. The Economist 1/3/08
Infrastructure funds on the rise
The Carlyle Group has introduced a $1.15 billion infrastructure fund that will help federal, state and local governments run public developments such as bridges, tunnels, highways and airports. Private-equity firms are becoming the new solution in completing and repairing public projects that tax revenues and municipal bonds cannot cover. Washington Post (1/3)
Private Equity goes global
The week has seen several deals with an international factor with either the purchaser or the acquisition being foreign. For example, AIG is buying a stake in Chinese motorcycle maker Lifan group; Indian chemical maker Tata Chemicals has purchased U.S.-based General Chemical Industry Products from Harbinger Capital Partners; CVC bids for a stake in Australian subprime lender MFS; and BC Partners has sealed its $16.5 billion deal for US satellite service provider Intelsat.
Another indication of the growing international future of private equity is Bain Capital's most recent fund. Bain is finalizing a $20 billion global buyout fund and has other funds dedicated to Europe and Asia in the works
Money from China
China may plow $4 billion into J.C. Flowers
The state-owned, $200 billion China Investment Corp. is poised to commit to a new fund run by the former Goldman Sachs banker J. Christopher Flowers. Wall Street Journal (2/8)
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