Private equity-backed companies weathered the recession significantly better than comparable businesses, according to a study released by the Private Equity Council.
The study found that the annualised default rate for the more than 3,200 private equity-backed companies acquired between 2000 and 2009 and held through 2008-2009 was 2.8 per cent during the two-year recession.
That compares to a 6.2 per cent annualised default rate for similarly-financed businesses.
“This study is an important contribution to an informed discussion about private equity ownership,” says PEC president Douglas Lowenstein (pictured). “The low default rate is another indicator that undercuts popular myths about private equity ownership and suggests that private equity firms are effective at steering companies through troubled times.”
The PEC’s findings are consistent with a variety of independent research studies conducted in the past few years, including a 2008 report by the Bank for International Settlements and a 2009 study by Steven N. Kaplan of the University of Chicago and Per Strömberg of the Stockholm School of Economics.
The BIS study found that private equity-backed companies had annualized default rates of 2.13 per cent from 1982 to 1986; 3.14 per cent from 1987 to 1991; 2.63 per cent from 1992 to 1996; and 3.84 per cent from 1997-2001. Kaplan and Strömberg reported a rate of 1.2 per cent over the 32 years from 1970 to 2002.
The PEC findings are at odds with forecasts made by credit rating agencies Moody’s and Standard and Poor’s and by the Boston Consulting Group that the default rate for private equity-backed companies would rise significantly during the recession.
Moody’s and S&P both have produced research documents suggesting that private equity-backed company default rates are higher than supported by the data analysed by the PEC. The Boston Consulting Group in 2008 predicted that nearly 50 per cent of the world’s private equity-backed companies would default in three years.
The PEC study notes that the Moody’s analysis expanded the definition of “default” to capture voluntary transactions to deleverage companies. S&P broadened its definition of private equity-related transactions to include a defaulted business that has had any dealing with a private equity firm, however minor, or however long ago, and includes holding companies in its definition of private equity firm.
In addition, the Boston Consulting Group, in an oft-cited study, used credit spreads at the height of the financial crisis to predict that nearly half of the world’s private equity-backed companies would default within three years.
The PEC study shows that during the recession of 2008-2009 private equity-backed businesses defaulted at less than one-half the rate of comparable companies: 2.84 per cent versus 6.17 per cent.
A large number of the transactions that ultimately defaulted involved little to no leverage. Some defaulted investments represented “all equity” investments into risky companies, some of which were acquired out of a previous bankruptcy.
The defaults tended to correlate to overall economic activity. For example, companies overrepresented in the default group were media companies struggling with declining ad revenue and new competition and auto parts suppliers devastated by the decline in US automotive sales.
It is highly unlikely that the cumulative default rate of private equity acquisitions will approach anything close to the highs feared by critics.
