private equity industry has not experienced the bounce back this year that many had been either expecting or hoping for after a very difficult 2009.
Yet despite a patchy and volatile 2010, there is a glimmer of hope that the recovery in portfolio values and confidence should become more entrenched in 2011, as bank financing slowly returns.
Buyout firms are still sitting on almost half a trillion of uncommitted capital that they raised prior to the financial crisis but which needs to be put to work before it has to be distributed back to investors.
Private equity managers are nonetheless being extremely choosy about which assets they snap up and at what price.
“We are beginning to see an increase in M&A activity as many private equity sponsors still have fresh powder to buy assets. What this means is that existing LPs [limited partners] should expect to see an increase in capital calls in 2011. In addition, investors should begin to see some distribution activity, which is what LPs have been waiting for,” says Gregory Getschow, managing director and co-portfolio manager of JP Morgan Private Equity Limited.
Larger deals are happening but many managers report that it is still difficult to obtain leverage.
According to the Centre for Management Buyout Research, equity contributions exceeded 60 per cent in the third quarter of 2010, compared to around 20 per cent for the large buyouts from 2005-2008.
Compared to those golden years, there are still far fewer deals taking place, which is having a knock-on effect. “At the larger end of the market, there are some very substantial firms with substantial outstanding commitments and capital available to invest but only a relatively small number of deals to chase and real difficulties around securing the right debt packages,” says Henry Sallitt, co-head and director of Fleming Family & Partners Private Equity, the multi-family office.
The small number of deals has made it more expensive to make new investments and as a result the larger funds are are now focusing on smaller than usual transactions in the £50m-£750m range, making that area very competitive, explains Sallitt.
Low investment activity and higher prices combined with a tight leverage market leaves fewer options of generating value in a company. But there is potential to create value from consolidating weaker competitors, says Katharina Lichtner, head of research at Capital Dynamics, an asset management firm focusing on private assets.
“We expect those managers that have experience with buy-and-build strategies and strong abilities to operationally integrate companies will be well positioned to generate attractive returns,” she adds.
Henry Sallitt says that at the smaller end of the market he believes it’s
a good time to be investing, particularly in development capital opportunities. “The lack of cash from the banks and the new issue market mean we are able to invest in situations with strong downside protection and equity upside. These circumstances don’t exist very often. If you are able to put debt-risk money into equity instruments then that is good business,” he says.