The barbarians are coming, again

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Jul 28th 2009
From Economist.com

There are signs of revival among private equity's giants


ALONG with the rest of the finance industry, the private-equity business has endured a miserable couple of years. Congress continues to plan heavier taxation of its profits, even though they have slumped. As banks, which had been lending buy-out firms spectacular sums of money on extraordinarily generous terms, abruptly turned off their taps, buy-outs became a rarity. In the first half of 2009, just $24 billion of private-equity deals were completed worldwide and only three loans were extended to fund leveraged acquisitions, the lowest number since 1985, according to Dealogic. That compares with deal volumes of $131 billion last year and $528 billion in 2007.

Meanwhile, the economic crisis has meant that many of the firms snapped up by private equity in the boom years have got into difficulties, so private-equity bosses have had to spend most of their time trying to keep them alive when they would rather have been selling them for a profit and snapping up new bargains.

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A deal private equity would rather forgetThere have been some notable casualties suffered by some usually reliable performers. Apollo could not save Linens ’n Things, a retailer, from bankruptcy. The purchase of Chrysler by Cerberus made the private-equity firm named after the three-headed dog guarding the gates of hell look like a different sort of dog when the carmaker filed for bankruptcy. But possibly the most ignominious loss in the history of private equity was suffered by the venerable Texas Pacific Group (TPG): it invested $1.35 billion in Washington Mutual in April 2008, only for its entire stake to be wiped out five months later when the mortgage lender went bust and most of its assets were bought by JPMorgan Chase.

Last week TPG’s founder, David Bonderman, was appointed to the board of post-bankruptcy General Motors, suggesting that the WaMu misfortune has not done too much damage to his reputation. That is one of several signs in recent weeks that the wind may be starting to blow in a better direction for private equity.

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First, a few deals have been announced. They are small compared with the blockbusters of the credit bubble, such as Blackstone’s $40 billion purchase of Equity Office Properties in 2007, but better than nothing. Bankrate, a financial-services website, has agreed to be bought by Apax Partners for $571m. Some private-equity firms have invested in life support for CIT, a troubled lender, on terms that have been described as “risk-free” and “Don Corleone financing”.

There has also been a twitch of life in the market for disposals, with the announcement that Vitamin Shoppe, owned by private equity, intends to hold an initial public offering (IPO), albeit a tiny one that may value the retailer at $150m. Still, given that the IPO market has been dead this year, and trade sales of private-equity-owned firms have also been rare, this is not to be sniffed at. Perhaps the exit market, which in the first half of this year has raised only $21 billion, compared with $115 billion in the first half of 2008 (according to Dealogic), is past its worst.

But the clearest signal that things are looking up for private equity is the news that the granddaddy of the industry, Kohlberg Kravis Roberts (KKR), is to revive its plans to go public—and fast. These plans were postponed after the bankruptcy of Lehman Brothers last September led to a meltdown in the financial markets. By early this year KKR’s partners were considering abandoning the IPO for good. Now, they are in a hurry to get it done. The IPO is due to take place in October, through a reverse merger of the holding company into a European unit that KKR floated in happier times. By this method, KKR gets a listing in Amsterdam at least a year before it could get one in America—though the firm says it will put in place corporate-governance measures designed to meet the high standards of the New York Stock Exchange rather than the less demanding Dutch requirements.

Why the rush? There is no evidence that Henry Kravis and George Roberts, the two founders still active at KKR, are looking to cash out, as was the case with Pete Peterson, a founder of Blackstone, which went public in 2007. It seems that KKR wants public equity as currency for rewarding and retaining other partners and for acquisitions (perhaps of other private-equity firms or financial companies). That means it sees opportunity.

Mention of Blackstone is a reminder that when a private-equity firm goes public, that is not necessarily a buy signal for the industry. Blackstone’s IPO marked the industry’s pre-crunch high point, and Blackstone’s share price has never since come close to its IPO level of $31 a share. Strikingly, however, having fallen to under $4 this March, Blackstone’s share price has since rallied to over $11—another sign that KKR may be getting its timing right. If so, it will be no surprise if IPO plans are soon announced by Carlyle and perhaps other leading firms.

For all its recent difficulties, private equity still has plenty going for it—not least an estimated $400 billion of uninvested capital. True, the credit-fuelled mega-deals of old are unlikely to return soon. Deals will be mostly financed with equity rather than debt, which means that private-equity groups will need to improve the fundamentals of the businesses they buy rather than just profiting from financial engineering. The first area to see an increase in dealmaking is likely to be “roll-ups”, in which firms already backed by private equity will consolidate fragmented industries by buying small competitors from their troubled owners.

However, for the big private-equity firms like KKR, the greatest opportunity may come in diversifying. Already KKR has raised money to invest in distressed securities and infrastructure development. It may also see a chance to snap up stakes in other private-equity firms through the fast-growing secondary market for limited partnerships. It also has an advisory business, and is said to see an opportunity in helping firms raise capital. With the investment-banking industry a shadow of its former self, could it be that the future of the newly public KKR, along with Blackstone and maybe others, will be to become increasingly like, and competitive with, Goldman Sachs?