Bain & Co.: Private equity downturn “rearranged established rules, reset expectations and planted the seeds of PE’s next phase”

Private Equity 18 Apr 2010

By: Konstantin Danilov, Editorial Board

PE in 2009: What happened?

As the global economic crisis began to abate in 2009, private equity continued to face challenges as anemic leveraged-loan markets, decreased fundraising levels, and increasingly higher deal valuations led to strikingly lower levels of deal volume. A recently released report by Bain & Company details the year’s events.  (Ed: This report contains a metric tonne of charts and data and is a must-read for anyone trying to conduct a post-mortem on 2009.)

Deal or No Deal

The most dramatic event in 2009 was the massive contraction in the leveraged loan market and the subsequent falloff in the number of private equity deals. Leveraged loans – the biggest source of financing for the PE industry over the last decade – fell from a peak of $500 billion in 2007 to a paltry $20 billion in 2009.

Needless to say, the debt that was available for LBOs came at a cost that was nearly double the levels a few years earlier. With less available leverage, both leverage levels and purchase multiples on deals fell, while equity stakes increased dramatically to 52 percent from 33 percent in 2007.

The peak to trough decline in deal activity is staggering – a 66 percent decrease between 2007 and 2009. While overall deal activity was at similar levels in 2001, the size of the industry was much smaller then than it is now.

Deep Value

There was no leverage, but at least PE firms were able to pick up quality companies at discount prices following the crisis, right? Unfortunately, this was not the case. The global equity markets fell and rebounded so quickly, selling prices for companies (typically derived from public market valuations) did not have a chance to adjust. In fact, EBIDTA multiples recovered to near-2007 highs by year-end after a brief reprieve in the first half of 2009. The heightened levels of economic uncertainty also made it difficult to make growth forecasts for target companies, further slowing down the deal pace.

The New Deal

Thankfully, the past year marked an end to mega-deals, which probably added more value to GPs and investment bankers in the form of fees than to investors or the companies themselves. While a quarter of all deals done in 2006 were $10 million or above, no deals of that size were done in 2009.

The types of deals completed also showed a marked change from the recent past; public-to-private transactions decreased as firms focused on carve-outs, growth equity, acquisition finance, balance sheet restructurings and distressed debt.


Unsurprisingly, fundraising was down drastically for the year. Funds also took longer to close, and some firms scaled-back or abandoned their fundraising efforts entirely. However, the pain was not felt uniformly across the industry; top firms continued to draw the lion’s share of the capital, with some prestigious players actually raising larger funds than in previous years.

The lack of funds did not stem from a lack of investor interest, it seems, but from a lack of liquidity. The denominator effect – the bane of private equity’s existence in 2009 – continued to inflate PE allocation to above-target levels in LP portfolios, and the quarter lag in PE valuations did little to alleviate the problem. By mid-2009, two thirds of LPs surveyed by Preqin were at or above their target allocations to PE. The cash-flow imbalance (more capital calls than distributions) during this time period further compounded the problem.

So whose default is it?

The most surprising statistic mentioned in the report was the level of defaults actually experienced by PE-backed companies, which is estimated to be around 7 percent. This is much lower than most people expected, given the notoriously high levels leverage employed by PE firms. Granted, some of the problems may have been swept under the rug or delayed, as a large amount of debt was refinanced. There may be more pain to come, as a large amount of leveraged debt is set to mature in 2014, which may prove problematic if credit markets do not improve significantly.

Change We Can Believe In

While private equity does not contribute to additional cyclicality in the economy, the industry itself is highly cyclical. Although the boom and subsequent bust was magnified dramatically during the past decade, it is not unreasonable to expect that the industry will somehow reinvent itself and come back stronger than ever.

However, it will be a shame if the current crisis does not force the industry to shrink to a more efficient level, whether measured by total assets or number of funds. Increasing numbers of club deals and mega-buyouts, exorbitant valuations and leverage levels, egregious fee structures (3 and 30 anyone?), and poor performance all highlight some of the symptoms of a deeper problem. Although there have been some slight improvements in terms, conditions and fees, the new era of private equity will hopefully bring greater transparency and a better alignment of LP/GP interests.

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