The Future of Private Equity

by: Howard Sun

Historically, the North American PE market has seen tremendous growth and development with significant domestic and cross-border inflows & deal making. The financial crisis has brought the global private equity industry to a virtual halt in 2008 through 2009.

Looking at the latest US numbers from Pitchbook, 2009 fundraising was down by about 55% from 2008 levels in terms of dollars and the number of funds closed. Q3 and Q4 of 2009 were hit especially hard as they generated only a combined 25% of 2009’s total fund raising. It now takes on average 18 months to close a fund vs. 12 months in 2007, another all-time high. There is approximately $1.1 trillion in dry powder globally and approximately $500M of that is in the US.

From an investment perspective, tighter access to credit and fewer willing sellers due to decreased valuations has caused deal flow to scale back significantly. In absolute dollars, deal flow dropped to an all-time low in Q2 and Q3 of 2009, while the number of deals declined to a lesser degree, suggesting that deals are getting smaller and we’re not seeing the mega-buyouts from prior years. Deal activity appears to be picking up in 2010 as those with an appetite for acquisitions position themselves for the M&A turnaround. So far, we’ve already seen some sizeable deals come through the door as well as significant activity in the mid-market. To name a few,

  • Bain Capital’s acquisition of Dow Styron for $1.6B
  • THL’s acquisition of CKE restaurants for $928M
  • Bain Capital, Advent and Berkshire’s (NYSE:BRK.A) acquisition of SkillSoft for $1.1B
  • CVC’s $774M investment in Matahari Department Stores

So where is PE headed in the future? We probably won’t see the large mega deals for a while as debt markets continue to unwind; mid-market deals will be the normal. PE firms will also be more likely in making minority investments as funds bridge the gap between tight credit and the need for capital. Investments will also more likely funnel its way to emerging markets. In addition, since high debt leverage will likely not return any time soon, cash deals will take precedence for the next while. From a portfolio management perspective, there has been and will continue to be increased focus on driving strategic and operational improvements to generate increased valuations. PE firms are also increasingly looking at more basic industries including industrials/infrastructure, consumer products, materials, energy & power etc. as these industries tend to be more recession resistant and tend to have high potential for value creation from an operational standpoint.

Studies have shown that deals done during a downturn yield higher returns than those in a bull market. PE firms should benefit in the long run once markets return to normal conditions. From an investment perspective, we can look at several publicly-traded PE firms including KKR (KFN), Blackstone (NYSE:BX), Apollo (NASDAQ:AINV), and American Capital (NASDAQ:ACAS). All of these firms have bounced significantly since March lows of last year and continue to demonstrate strong growth potential.

Disclosure: No Positions

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