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Secondaries market presents opportunities for private equity firms, says SEB

The prospects for private equity companies that are properly positioned appear attractive this year, according to a report by Swedish investment bank SEB.

The report says there are plenty of companies to buy and sellers seem to be starting to accept the prevailing price levels.

Target companies can now be bought at lower initial prices than before, and they probably have a greater need for operational reform.

Even if a strained credit market means lower loan-to-value ratios − which means lower leveraging of the investment − and more expensive borrowing, well-managed private equity firms should be able to grow nicely in the future, says SEB.

History also shows that private equity companies have generated good returns in the wake of recessions.

Bank lending to private equity has gradually resumed. A number of transactions have recently been announced in which it is clearly apparent that banks are again helping to finance private equity companies, albeit at lower loan-to-value ratios than during the peak years.

Activity is also increasing in the corporate bond market, where the companies can obtain financing, admittedly at high cost but without covenants. There are also new creative financing solutions, with certain pension funds among the players.

On the other hand, access to capital remains scarce. Banks remain under pressure, and political initiatives are disrupting the picture. In particular, President Obama’s proposal not to allow banks to own private equity companies or funds risks turning up pressure on the market. In addition, there is probably still a great need for many PE companies to divest holdings for financial reasons, says SEB.

However, the report says these risks also represent opportunities for those that have weathered the crisis well. For private equity companies that have money to invest there should be good opportunities to buy secondaries at attractive prices when banks and others may sell them in the future. In this market, transactions are taking place today at a discount of up to 25-30 per cent of companies’ net asset value. After a year with few transactions, SEB expects volume to triple in 2010.

Most observers agree that the market for new private equity funds will remain cautious this year, with significantly lower volume than during the record years 2006-2007. This is also good news for those market players that are strong today, since fewer rivals will be competing for the good targets.

Among the various segments, SEB is most positive towards the potential for acquiring small and medium-sized companies − in part because they do not attract as much capital in external financing and partly because there is more often room for a professional corporate governance model in order to make a difference in the value of the company.

Megafunds, which raised enormous sums during the peak years to make speculative acquisitions of the largest companies in the stock market, are probably a phenomenon consigned to history.

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