Grey skies are gonna clear up – for private equity

Private Equity 01 Aug 2010

Unless you’re a big fan of hail, sleet, snow, wind and other inclement meteorology, the best part about a bad storm is when it finally passes. A recent report by Rothstein Kass on the private equity industry certainly suggests the worst credit crisis storm in history is over and that sunny skies are here again.

The report, “Private Equity in 2010,” (click here to download the full PDF version; click here to view the press release), is indeed pretty bright and sunny, with roughly one-third of private equity firm managers convinced the credit crisis clouds had already parted last year and an additional 10% predicting that market weakness will dissipate any remaining cloudiness before the second half of this year.

In an even brighter forecast, a full than 80% of private equity professionals surveyed believe that if there are still lingering clouds out there, that they’ll be gone before the second half of 2011. The results were based on responses from just under 200 private equity firms conducted during the first and second quarters of 2010.

But just because the clouds are gone or expected to be gone doesn’t mean there isn’t concern about another storm hitting. While optimistic, many private equity managers still expect some additional stormy weather, particularly on the capital-raising and regulatory oversight fronts. Indeed, nearly 77% of respondents are expecting increased regulation of private equity firms, while 70% predict it will be tougher to raise new capital this year than in 2009 (see chart below).

Source: Rothstein Kass

But it’ll still likely be just some spotty showers, according to Rothstein Kass. In 2008 and 2009, “discrepancies between the owner’s perceived value and the price that potential acquirers would pay, kept private equity capital on the sidelines,” the report notes. “With lending again less restricted, this gap has started to narrow, leading to renewed activity.”

Almost half of private equity managers expect more fund launches than in 2009, while only a third anticipate more closures.

Source: Rothstein Kass

To gauge the forecast as best as possible, many are looking to the private equity industry for news of the next mega-deal as a potential harbinger of better days ahead, the report also notes. Still, according to Tom Angell, head of the Rothstein Kass private equity practice, activity among small- and mid-sized private equity funds is a better predictor of the sector’s improving health “and could indicate the start of a sustained recovery.”

“To compete effectively with multi-billion dollar funds while syndicating risk, smaller firms will be more likely to pursue club deals for larger acquisitions,” Angell says (see chart below.)

Among other findings in the survey:

  • Over 66% anticipate greater involvement with portfolio companies;
  • More than 77% expect it will take longer to sell portfolio companies;
  • Nearly 39% expect that private equity firms will more frequently form consortia to execute large transactions;
  • About half of respondents are expecting increased IPO activity in relation to portfolio companies in 2010;
  • Slightly more than 30% see IPO proceeds being used primarily to finance future transactions, while nearly 56% believed IPO proceeds will be used primarily to strengthen other portfolio companies.

“Most private equity managers recognize that greater involvement with portfolio companies will continue to be essential to unlocking long-term enterprise value,” says Angell. “With exit strategies uncertain, those private equity firms that are able to sell portfolio companies will be more likely to use the proceeds to bolster other portfolio companies than to pursue other transactions in the near-term.”

Overall, a pretty solid leave-the-umbrella-at-home forecast for the private equity world – one that jives with other recent reports and forecasts we have looked at. It’s worth keeping in mind though that even in an age where forecasting has become a science, there are still greater-than-average odds of getting it wrong – even if you’re on the ground and staring up.

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