2009 US private equity watch: an industry in flux
Like many other industries, private equity retreated last year amid tight credit and a lack of market confidence. Total US deal volume fell sharply, a trend that carried into the first quarter of this year. Moreover, leverage was scarce in 2008, leading private equity acquirers to put more equity into deals.
Smaller deals were decidedly in vogue last year as mega-deals of $5 billion or more disappeared. Now, firms are examining opportunities ranging from minority investments, direct equity investments in public companies and public/private partnerships to “loan-to-own” transactions and smaller, more traditional private equity buyouts. Those with ample capital have more options, but face longer holding periods and higher equity requirements. As firms seek opportunities requiring less leverage, they risk “style drift” as the alternatives may involve more risks than traditional private equity investment strategies.
Currently, there are two emerging market arguments on the future of private equity:
1.Those who believe the industry derives its strength from leverage contend that the model is broken, at least until confidence returns and credit begins flowing at meaningful levels.
2.Those who believe private equity’s biggest assets are its flexibility in making investments – and its capacity to drive change and build operating value – see tremendous opportunities ahead.
What private equity has to offer
Private equity has much to offer the US economy as the country moves from deep recession into the early stages of recovery:
- It has capital. It is estimated that private equity firms have between $500 billion and $1 trillion in deployable capital.
- It has the temperament to be an early mover. According to economic advisory firm Sonecon LLC, private equity investments grew faster than private sector investments in the years following the end of three of the last four recessions.
Investment opportunities
Unlike other recessions of the past 35 years, the current downturn has affected all industries — creating broad investment opportunities. Turnaround opportunities will include sectors adversely affected by declines in consumer spending and beaten-down manufacturing and financial assets. Growth sectors in need of capital once recovery is underway include renewable energy, cleantech and infrastructure, which will benefit from federal stimulus programs.
Interest in “loan-to-own” transactions and distressed debt is growing, with some firms allocating general buyout funds for these purposes. Even so, the prognosis is guarded. The nature of funds closing in the last few years has changed significantly. Although distressed debt commitments nearly quadrupled from 2005 to 2008, from $11.2 billion to $41.2 billion, distressed funds lost momentum in the first three months of 2009 with no fund closings. Meanwhile, more financial services companies may seek to divest their asset management businesses as they attempt to bolster capital levels in a bid to avoid (or extricate themselves from) government support and intervention. Many stand-alone asset management firms may be targets. Private equity firms are one of only a few investor classes with available capital and are likely to figure as buyers in future deals.
Many prognosticators expect a significant shakeout among private equity firms over the next few years. Surviving firms will emerge stronger, and if history is any guide, the capital invested over the next few years is likely to yield high returns. Survivors will be those firms who focus on the core private equity competencies: backing great management teams, achieving real operating improvements, and building value at their portfolio companies. Firms that thrive will apply greater discipline and thoroughness to their due diligence on new acquisitions, regardless of whether they are snapping up assets from distressed firms or investing in growth niches.
As history has shown, private equity firms are flexible investors and adaptive in volatile markets. The underlying business model of private equity firms has been demonstrated to be effective in both up and down cycles. Over the last 35 years, private equity firms have evolved and emerged stronger after each economic down cycle—this trend is likely to continue.
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