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Poll reveals tough outlook for private equity

In the latest survey of financial sponsors conducted by Private Equity News, 45 per cent of over 600 respondents said the repercussions of the credit crunch would be felt for years.

In the latest survey of financial sponsors conducted by Private Equity News, 45 per cent of over 600 respondents said the repercussions of the credit crunch would be felt for years.

A further 53 per cent said the downturn would be corrected within one to three years from the start of this year – i.e. at least two years after the downturn started and up to five years in total. Less than one per cent saw no change.

Marco Franzini (pictured), head of international private equity at Simmons & Simmons, which sponsored the poll, says: ‘Those who took advantage of the credit boom will share the pain of the credit crunch and resulting global financial crisis and for the foreseeable future. The most obvious characteristics of the liquidity boom (including covenant-lite loans and very aggressive auction processes and sale documentation) will disappear for the foreseeable future. However, people have short memories, and today’s lessons might well be forgotten tomorrow in the race to deliver future returns, so any change in private equity might not be so fundamental or so permanent. Time will tell.’

Arthur Stewart, head of private equity at Simmons & Simmons, adds: ‘There is a need to differentiate between short-term changes in the market such as having less debt and there being more distressed companies, and longer-term structural changes, including the structure of private equity funds and their carry and fee arrangements. Although we can expect investors will carefully [go through] due diligence [on] their managers’ past record and may question the promises made by firms about how they will achieve the returns, the expected debate on fee levels and profit shares will be tempered by the quality of the manager and its track record.’

The consequences of the credit crunch have also affected people’s concern about the biggest risk facing the industry this year. Nearly half of those responding said the ability to find financing for deals was their biggest concern.

One-quarter said the prices paid using the high leverage levels available in the run-up to mid-2007 caused them greatest concern. The remaining portfolio companies were often bought using record multiples of price-to-earnings before interest, tax, depreciation and amortisation – about nine times in 2007.

Given the contraction in credit availability and investor sentiment, multiples on new deals have dropped, which will affect the exit prices obtained if private equity funds need to return cash to their investors.

Along with debt multiples contracting, many companies’ underlying ebitda has started to fall as the credit crunch bites into the real economy – the businesses rather than just the financial system.

The third biggest concern reflected in the poll was the global economic downturn and the western recession. There were also growing fears that regulation and legislation to deal with the after-effects of the credit crunch would also hit the private equity industry.

However, given the long-term, locked-in funding structure of the industry, there is still plenty of committed capital waiting to be deployed. Research by Private Equity News using data from Preqin and Bloomberg showed the top 20 cash-rich private equity firms and trade players had more than USD 700bn of money waiting for new deals.

Most of this money, if limited partners allow it to be drawn down, is looking at niche areas, such as follow-on or bolt-on investments or minority deals rather than venture or growth capital or mid-to-large buyouts.

Across the globe and in almost all sectors, deal activity is expected to be down this year and LPs less keen to commit to new funds as returns continue to dip.

Stewart adds: ‘All indications are that 2009 will be a tough year for the industry as the aftershocks of the financial crises are felt in the global economy and, in turn, in portfolio companies and as long as there remains a scarcity of debt finance.

‘However, as valuations fall there will inevitably be opportunities for cash-rich private equity firms in private and public securities and this is something borne out by the results of this recent poll.’

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