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Private equity – A return to form in 2011?

The recession and credit crunch took its toll on private equity investment companies, however, owing to recent strong performance, the private equity sector has bounced back. With the popularity of private equity investment companies seemingly on a steady rise, the Association of Investment Companies (AIC) has canvassed the opinions of managers to discuss the prospects for the sector in 2011.
 

Increasing value in underlying portfolios has contributed to a lift in the share price of many private equity companies; the average private equity investment company is up 23% over the last year, compared to a 12% rise in share price for the average investment company.
 
Alex Barr, manager of the Aberdeen Private Equity Fund Limited, says: “Listed Private Equity has enjoyed a return to favour of late, and is likely to continue to do well through 2011. Investors are returning based on increased optimism for Private Equity fundamentals and encouraged that many quoted Private Equity Funds are seeking to address liquidity issues. Increased levels of M&A are providing a better exit environment and lifting valuations at which unrealised companies are being held in portfolios.”
 
Peter McKellar, manager of Standard Life European Private Equity Trust says: “We see the outlook for listed private equity as largely positive, given an expected narrowing of share price discounts to NAV and increasing valuations. Those increasing valuations should be underpinned by solid earnings growth at underlying investee companies, particularly those based in northern Europe.”
 
Emma Osborne, Head of Fund Investment at Graphite Capital Management emphasises the value which could be released from underlying assets:  “With many private equity managers preparing for fund raisings in the next 12 to 24 months, they will be looking to achieve strong exits from their current portfolios.  This is likely to drive both higher realisation proceeds than last year and NAV growth, as sales still tend to be at good premiums to holding values.”
 
The turbulence of the recent financial crisis has created some opportunities for managers of private equity investment companies. Tim Levett, Chairman of NVM, managers of Northern Investors, believes that timing is key: “The opportunity for the sector is to invest at the right point in the cycle to take advantage of the recovery when it comes. Changes to Capital Gains Tax and generally brighter prospects are encouraging more owner-managers to consider selling their business to their managers.  We are currently seeing good opportunities at realistic prices.”
 
“Opportunities abound” says Alex Barr, manager of the Aberdeen Private Equity Fund Limited: “In particular we believe that at a sector level technology and financial areas are amongst the most attractive. At a country level we still see significant opportunity in developed private equity markets, but will selectively look to add opportunities in Asia, and some of the more peripheral markets such as the Nordic region.”
 
The recent recession has left the private equity sector bruised but with a renewed sense of discipline, as Peter McKellar, manager of Standard Life European Private Equity Trust recalls: “The credit crunch resulted in a significant dislocation in transactional activity, with few new deals completed and very few disposals. In light of this, the sector as a whole has become more cautious in terms of running over-commitment strategies. The same can be said for Standard Life European Private Equity Trust.”
 
Emma Osborne, Head of Fund Investment at Graphite said: “Graphite Enterprise has always been at the more conservative end of the spectrum when it comes to balance sheet management and we took early action in 2008 to make sure we had sufficient liquidity to see out the downturn.  The credit crunch has not changed this cautious approach (in fact it has reinforced it), nor the company’s investment focus.  One thing we will do a bit differently going forward is to increase the proportion of the portfolio in secondary fund purchases and co-investments which will give us greater control over the company’s cash flows.”
 
The recession, says Tim Levett, Chairman of NVM, managers of Northern Investors, has influenced his view on potential investments: “We are much less inclined to take on board significant bank debt in our investments.  Whilst banks are continuing to lend, the level of funding available for smaller companies has reduced over the past three or so years. This has created a gap that is being filled by private equity funds.  Whilst most private equity investment has been in highly leveraged buy-outs, we have never relied on large debt multiples to drive our returns.”
 
Despite the optimism currently surrounding the sector, managers warn not to get too bullish. Caution is the order of the day, suggests Alex Barr, manager of the Aberdeen Private Equity Fund Limited: “Exuberance may be the principle risk and we would not welcome a rapid return to premium valuations, though we feel this is unlikely to happen for some time. Likewise we need pricing and leverage discipline from large buyout houses who bear a significant amount of responsibility for the damaged private equity environment from which investors have only just returned.”
 
Tim Levett, Chairman of NVM, managers of Northern Investors sees external pressures as a potential crux for the sector: “The key risk is the slower than anticipated growth in the economy. Whilst many SMEs have focused on growing their export business, in most cases the UK remains their biggest market.  Those companies depending on consumer demand are likely to struggle, but companies that are either service or manufacturing orientated are in our experience doing much better.”

Outside of the UK, Peter McKellar, manager of Standard Life European Private Equity Trust is wary of similar conditions: “Clearly the risks are more from a macro perspective, in terms of a low growth environment, enhanced by fiscal retrenchment in parts of Europe and, in southern Europe, the on-going debt crisis. Overlaying that, the first quarter of this year has seen fewer buy-out transactions completed, as some of these factors and the political crisis in North Africa and the Middle East has made managers more cautious in closing deals.”

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