EquityFC Blog

More on secondaries | 28 April 2009

Although I've been enthusiastic about the prospects for deal activity to rise thanks to an improving environment for IPOs, it would be remiss not to note that there's also evidence that it's PE houses, not corporates, who are getting more realistic about asset prices and thereby boosting deals.

Take the news a couple of weeks ago that "Goldman Sachs Group's asset management unit has raised $5.5 billion from investors to start a fifth fund dedicated to buying private equity investments on the secondary market". I can't believe Goldman has a tonne of bankers drooling at the thought of providing massive leverage to these deals. So the value must be in two areas. Recovery plays - because almost anything you buy in a recession must deliver better performance by the end of 2010. And distressed sales. Many PE funds must be reaching investment horizons and will need to crystalise value - even if that value's not as much as they'd like.

I posted yesterday that secondary buyouts tended to the frothy side of deals, especially compared to IPOs and trade sales. That's still true - but if Goldman's funds are planning to snap up assets on the cheap and build them through a recovery, that's still better than naked financial engineering. And that sort of deal is much more fun for FCs and FDs, too. It's about creating value - not just scrambling for cash to pay down debt.

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Green shoots! | 27 April 2009

Good financial execs are always in demand by PE firms and their portfolio companies, whatever the economic climate. But more opportunities (and more interesting ones) tend to arise when there's a bit of churn in the market. MBOs help because a former divisional FC might not cut it as a PE-backed FD – and their replacement will need his or her own FC in turn, for example. The problem during the "crecession crunch" has been a decline in that level of churn. Only the other day, the editor of Real Deals was bemoaning the lack of deals to fill pages in the magazine.

Yes, some sectors have seen real drama, leading to distressed sales - but there aren't that many PE firms with the expertise in insolvency, hardcore turnaround or radical change to make picking up the basket cases that attractive. And, despite widespread fears over corporate debt default rates, not that many BigCos have felt the need to hive off divisions to management on the cheap (assuming management can get backing, even if asset prices have been atractive).

But at the risk of incurring the wrath of readers, there seem to be green shoots. (People routinely get angry at the mention of those two little words, as if it's rude to seek out optimistic signs. They get angry with me because my predictions often turn out very wrong.) Today's FT, for example, runs with the headline: "Itchy private equity ready for IPO spurt".

This story is important to two reasons. First, and most obviously, with stock markets showing some kind of stability, exits can get going again. Hurrah! That means a bit of churn, some cash freed up for fresh deals and greater optminism in the PE community. When they're optimistic, they deal more. QED.

Second, it also shows that PE is getting back to a much more stable way of doing business. Looking to flotations - rather than secondary buyouts - as a means of realising value from an investment is inherently more stable than relying solely on other PE firms coming in for assets (although trade sales should, in theory, always realise the most value - when they start to climb, we're into giant beanstalk territory). I always felt the rise in secondaries was a symptom of a reliance of financial engineering. It suggests a financial buyer can price a trade or public buyer out of the market, which flies in the face of common sense.

So two cheers for the green shoots of PE IPOs. I'm holding back one cheer - the Telegraph is citing the 2009 Preqin Global Private Equity Review which claims new accounting rules forcing PE firms to hold assets at current disposal values (rather than historic cost) will boost... the secondary buyout market. The review states: "Eight of the 20 secondaries vehicles currently on the road are targeting commitments of $2bn or more. If these vehicles were to close on target in 2009, they would raise aggregate capital of almost $27bn." Sigh. Well, I guess it's stll churn...

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Alistair Darling, business angel | 6 April 2009

OK, so that's the most misleading headline I've ever written. But the news that ironmonger Robert Dyas is close to completing an MBO backed by Lloyds TSB - wiping out existing PE investor Change Capital - does, sort of, bring the government (the biggest shareholder in the bank) into the realm of private equity. The decision has been greeted by some as a sign that a state-backed bank is prepared to intervene to save jobs (in this case, 1,200). But that's not true - and there's something more significant going on here.

At its heart, this isn't a government bail-out - it's a smart investment decision. The bank (actually, AIB is also into Dyas for a fair chunk of change) has looked at what is basically a decent company - it's still profitable - and decided that it's loans are better served by taking over from the equity investor than by liquidating. Crucially, it's brought in new management to ensure the business is run with more discipline. Former Kingfisher and MFI director Stephen Round (OK, he's a marketer, not an FD...) and corporate turnaround specialist Ian Gray, an accountant by training, will take over. With revenues of £100m, they should be able to manage cash more aggressively and keep the thing going quite happily. Does this mean banks across the land have remembered that helping to finance businesses in temporary financial difficulty is their job? Probably not. But it's a high profile example that they do sometimes remember to apply common sense.

It also shows how the old private equity leverage model is, well, broken. Change Capital only injected £10m when it bought Dyas for £61m five years ago (as well as handing over £17m to the incumbent management team!), a decision that now looks foolhardy. OK, so its downside is limited to £10m, but without all that debt to service, who knows how long Dyas could have traded quite happily - into the upturn, probably, and a much better result for the investors and the banks. That's not a direct criticism of Change - my target is the model than prevailed in the boom years for PE, when returns were the only consideration and too much financial risk was lumped into investments. (Mind you, with luminaries such as former M&S boss Luc Vandevelde on the board, you'd have thought they could have made a better fist of running a retail business.)

Final point: robust, well-established mid-market businesses like Robert Dyas are more than capable of weathering the downturn. Heck, with Woolworths out of the picture, Dyas is pretty much the only High Street ironmonger left trading, so it ought to do well. (I love it, personally. Bought a sweater de-bobbler there this weekend.) But they need sensible backers and, crucially, disciplined financial management to do so. Dyas is a reminder than in additional to tightly-controlled finances, PE-backed companies need to be operating under the right long-term financial strategy, too. Massive leverage at a time of wobbly cash-flows isn't it.

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PE investment: media spinning a bad news story? | 2 April 2009

There's a fair bit of coverage today for the news that Q1 private equity fundraising has fallen to "a five-year low". The headline in the FT was cataclysmic for the sector: "Investors steer clear of private equity funds". So is all lost? Have investors jumped ship completely, as that headline implies? Not quite.

Let's start by getting a little more sanguine about those fundraising numbers. Here's the quote (which probably comes from a press release, given that it's repeated almost verbatim in the Indie, the FT and elsewhere): "A total of $45.9bn (£32bn) was raised for 71 private equity funds in the first quarter of the year, according to Preqin. This is the lowest figure since the final three months of 2003, when $34bn was raised as the global economy emerged from the slowdown resulting from the implosion of the dot.com boom. The total compares with $125bn raised in the fourth quarter of last year."

That is a big drop, alright. But given that the compound annual growth rate for funds raised between 2003 and 2007 was 47.6%, something had to give. Bear in mind also that 15 years ago $46bn would have been a stellar result for the whole year, never mind the second quarter of a major global recession. It's still a heck of a lot of money.

The press release goes on to talk about the number of funds extending or postponing close - a sign, clearly, that they are in biiiig trouble. Well, sort of. More importantly, it continues: "the number of active fundraisings has continued to rise year on year. In January this year there were 1624 funds on the road targeting $889bn, compared with 1304 funds chasing $705bn in January 2008 and 918 targeting $396bn in January 2007. By March this year, the number had risen to 1673." Well no wonder some funds are having trouble closing!

Apart from anything else, anecdotal evidence suggests that many funds are over-capitalised and have been for a couple of years. A dearth of deal opportunities - prices have only fallen hard for assets you really wouldn't want to buy - means many PE firms are holding tight and waiting for some sign of what we can expect from the economy in the medium term. At heart, many PE managers are just arbitragers: their skill is spotting the upturns, either for individual companies or whole sectors, before anyone else.

So not only is the FT headline about investors steering clear wrong - I think we'll see much more activity from PE firms in the back half of the year. By then, many corporates will be feeling the pinch of lower cashflows and expensive re-financings and will have to be offloading good businesses at reasonable prices. Punting on an end to economy contraction in H1 2010, PE firms will start buying, aiming to find both "rising tide" returns and get stuck in with restructurings and consolidations aimed at exploiting new economic realities beyond 2012.

That's where you come in. Right now, much of the demand for finance execs is coming from PE-backed companies working hard to survive. Good planning, iron-willed control of cash and great communication skills are the watchword. But hold tight later this year: when new deals start rolling, PE firms are going to be looking for finance execs who can combine those skills with the ability to bring discipline to growth and creativity to structure. It's gonna get interesting...

Meanwhile, the mainstream media - as yesterday's G20 coverage shows - just love to manufacture short-term scare stories. After all, they're just tomorrow's chip wrappings...

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Look East - but keep an eye out at home | 1 April 2009

the UK private equity scene looks fairly quiet at the moment. But PE managers are nothing is not resourceful, so it's interesting to note their interest in parts of the world where deal activity might be on the up.

One such example is the Gulf states where, according to PrivateEquityBlogger, Carlyle has just committed a $500m fund. (It also covers North Africa, interestingly...) At a recent conference in Dubai, Abraaj Capital CEO Arif Naqvi explained why the Gulf is interesting PE firms: "The public markets are paralyzed and closed, not just regionally but globally. Well, we are the alternative option. Private equity has a good name in this region. People have seen how value has been created."

Well, well. Because if that's true of the Gulf states (which are far from being unaffected by the global recession), it's also true of the UK. And if you translate developing economic interests in North Africa and the Middle East into innovative businesses in the UK, you can make a convincing argument that the mid-market privately-held sector is where it's at for ambitious finance execs.

The rationale is simple: recessions change the rules. They make giant companies look ponderous and bloated. And while fast-growth companies might have raised cash in flotations ten years ago, these days "the public markets are paralysed" - giving PE firms an opportunity to invest those dormant billions and risk-alert execs the chance to be part of the kind of businesses that will change the game post-recession.

Some of those execs will be tempted overseas to deploy their skills in fast growth businesses in the Middle East - others will see that similar openings can probably be found no further away than East Anglia!

(Incidentally, while we're looking East, check out some of the inspiring start-up talk at Indian blog StartUpCentral. Recession or not, there will be entrepreneurs and there will be game-changing businesses that can grow quickly with the right financing - and financial management.)

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