Private equity adapts to the new climate

"Houses have the luxury of waiting to see where the markets are going" Malcolm Wright, KPMG

Private equity firms raised $163.5 billion in the first three months of the year, with six leveraged buyout companies raising $82 billion in the quarter, up from $64 billion in the last quarter of 2007, according to Private Equity Intelligence, a research company. However, leveraged buyout firms led only $73 billion of takeovers this year, which is less than a third of the $234 billion of deals announced in the same period in 2007.

A stream of bad news has emerged from the private equity industry recently. In March, the manager of the world’s biggest buyout fund, Blackstone Group, announced that it had suffered a 90% drop in profit during the fourth quarter, with economic net income falling from $808 million to $88 million. Its management warned that conditions would remain difficult for the rest of the year or longer. Also in March, Carlyle Capital Corp, a highly leveraged mortgage-backed securities fund listed in Amsterdam by the Carlyle Group, another big private equity player, defaulted.

Malcolm Wright, a partner in the US private equity group of consultants KPMG in New York, says that when it comes to raising money from investors, private equity firms are still benefiting from cash commitments that were made before the liquidity crisis emerged. "Private equity funds are flush with committed funds – last year was a very big fund-raising year," he says.

But while cash from investors might still be coming in, with credit markets seized up it is becoming much more difficult to deploy that money. In the period leading up to the credit crisis a number of mega-deal transactions emerged in the form of multi-billion dollar buyouts usually put together by consortia of private equity companies. In 2005, for example, Carlyle Group, Clayton, Dubilier and Rice, and Merrill Lynch Global Private Equity came together to complete a $15 billion acquisition of car rental company Hertz. But the credit crisis has put a stop to these types of massive deals, at least for now.

"The credit crisis effectively stopped the mega buyout market in its tracks," says Arthur Stewart, a partner and private equity specialist at London law firm Simmons & Simmons.

Re-examination

Wright says a lot of private equity firms will be re-examining the assets they’ve already bought to see how they can make improvements in those companies. "And they will also be looking to use some of those companies as platforms for add-on acquisitions, more in the middle market, where loans are still available. Those loans tend to be non-syndicated, held to maturity and typically subject to normal covenant relationships," he says.

Competition for middle-market assets could therefore increase. However, moving more into this area – which can be thought of as the $250 million to $500 million bracket – could present difficulties for the biggest houses. Stewart says the big private equity businesses do not have enough investment professionals to do many more times the number of deals they are used to. Private Equity Intelligence estimates that the average private equity firm employs 38 people per $1 billion of assets under management. But at the bigger firms that drops to 15 or fewer.

Instead, the credit crisis could act as a catalyst for a trend that was already emerging in private equity: completing deals outside the usual US and European spheres, where private equity players feel most comfortable. The $1.3 billion acquisition of Turkish cargo shipper UN Ro-Ro last year by Kohlberg Kravis Roberts showed that the biggest players are looking across the globe, and particularly in emerging markets, for new opportunities. Debt finance on the deal was provided by Turkey’s Garanti Bank and Is Bank, which showed that private equity players are able to adapt to the absence of European and US bank credit facilities, at least for certain transactions – local buyouts financed by local banks in emerging markets.

Wright says he expects to see more deals across emerging markets but says many private equity houses, as they adapt to the new investing environment, will not be in a rush to invest committed capital. "They have the luxury of not having to invest immediately. They have the luxury of waiting to see where the markets are going," he says.