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Summer Meltdown?
Marc Raybin, Editor in Chief, July 2008
As most of the country bakes in the summer heat and investors (who can afford to this year) take their vacations, one might think private equity would be put on hold. To the contrary, there are more than a few hot topics in the asset class that should be important to investors this summer and beyond. It has been a dismal year for the American economy in general and private equity is certainly no exception. Hopefully, the asset class will not wilt in the summer heat.
One of the hottest sectors will continue to be energy. Dan Reid, the national managing principal of transaction advisory services at Grant Thornton, points specifically to a continued focus and consolidation of the oil and gasfield industry. Reid says this part of the sector is particularly fragmented and run by mom-and-pop shops within a 150-mile swath in the southwestern part of the country. These are prime pickings for private equity investors since a number of these companies are not being taken over by family members. The good news for energy investors is that even if the price of oil dropped quite a bit, it will still be profitable.
For the deals that are to be made this summer and for the second half of the year, investors’ approaches will have to change. Due diligence will certainly continue to take a more prominent role. As recently as 18 months ago, deal-makers would put together an agreement and have a fair amount of confidence that it would be held together with the debt financing that would come from somewhere. (Remember those days of easy credit?) Nowadays, however, the same people must be doubly sure the deal metrics are spot on because, if they are not, then financing may never materialize or could just disappear.
“People are going into deals today knowing they may have to walk away,” says Reid.
Private equity overseas is also feeling the heat. According to Paula Beroza, managing director at Sierra Asia Partners, private equity in Asia is seeing a continuation from the first and second quarters of a slower paced deal-making atmosphere. This is happening as a result of a tightening of the public markets in China and Hong Kong and bank loans continue to be held up. (Sound familiar?) As a result, Beroza says there will be more later-stage private equity deals because companies that would have gone public in the recent past are opting to turn to the private market. That will benefit investors in the asset class, as deal sizes will inevitably rise, according to Beroza.
As a result of all of this, private equity deal pace in Asia has slowed considerably. The anomaly, according to Beroza, however is not that the pace is slower these days, but rather that the speed at which deals were getting done last year was out of the norm. Beroza jokes that these days, exiting an investment after only 12 months is pretty much out of the question.
“It is getting back to a better balance,” she says.
As any investor worth her salt would do, Beroza is keeping an eye on next year. In addition to the near future, Beroza can see there being more deals made sometime next year. A lot of money has been raised that is currently sitting on the sidelines. Limited partners will expect to see their capital invested rather than sitting in the funds’ coffers and doling out maintenance fees all the while.
Speaking of having an eye beyond this summer, many people are looking at the U.S. Presidential elections in November as a key to what will happen in the private equity space. A number of people in the asset class, not surprisingly, are in favor of a Republican president in Sen. John McCain and do not relish a Democratic president in Sen. Barack Obama. The reasoning centers primarily on how each presidency would affect the tax code.
“The industry has been clearly identified by very high profile politicians in Congress as a potential cash cow, a source for tax revenue for the U.S. government at a time when so many other industries - and particularly those in financial services - are experiencing dramatic setbacks,” says Steven Huttler, an attorney with law firm Sadis & Goldberg. “The private equity world has gone from being a very low key player, almost non-existent, in prominent political circles, to inserting itself aggressively to try and protect its prerogatives and position. The million dollar question is how successful they will be in the current political environment, which disfavors them. The upcoming elections are therefore a very important milestone for the industry, and likely to have long term effects on its future.”
To be sure, Huttler is not alone in keeping a close eye on which way political winds will blow when it comes to the carried interest question, which has apparently been tabled until the election. Pierre Weiner, a partner in the Los Angeles office of law firm DLA Piper, puts it more bluntly.
“If a Democrat gets in, the capital markets likely will go to hell in a handbag at least in the short term,” he says. “Capital gains [taxes] will go up, which means that we haven’t even begun to see the bottom in the stock market.”
