Private-Equity Forecast
Thanks to cheap debt and aggressive pension funds, 2006 was the year of private equity. So what’s in store for these dealmakers in the year ahead?.?
Every few years there’s a shift in the type of financier that becomes the rock-star embodiment of capitalism unfettered. The ’80s icon was the investment banker. The ’90s belonged to the venture capitalist. And if the first years of the new millennium went to the hedge fund manager, the player who now gets all the love is the private equiteer. Once the scourge of companies and CEOs, the buyout firms are now wooed by potential acquirees and hailed as corporate alchemists who can take over a company, work their magic on its operations, and then exit to massive profits in an IPO.
The numbers illustrate the ascendance of PE. A startling 1,010 U.S. companies were taken private last year through Dec. 13–compared with 664 in 2004 and 324 in 2001–according to Dealogic. The total pricetag for the 2006 buyout splurge: $371.4 billion. And that didn’t even include the year-end volley-and-thunder of Harrah’s ($17.1 billion), Biomet ($11 billion), or Realogy ($6.7 billion). Every week in 2006, it seemed, private-equity firms announced what would have been the largest deal of the year in any other era.
“[We are] the face of 21st-century American capitalism,” says Carlyle Group co-founder David Rubenstein. That proclamation would’ve been outlandish not long ago; now it seems only mildly self-serving. Carlyle’s 2006 highlights included pieces of the $14.6 billion Kinder Morgan acquisition and the $17.6 billion Freescale Semiconductor deal. “American capitalism used to be General Motors and Ford and IBM,” says Rubenstein. “Now it’s Blackstone and Texas Pacific Group and KKR and Carlyle because we’re doing so many things to move the economy.”
Several factors have fueled the PE boom. Lenders are offering the buyout firms money on the cheap and with more relaxed loan restrictions than in the past. Institutional investors, notably pension funds, have been funneling more money into buyout firms. “In the U.S., pension fund managers were allocating 4% [to private equity] four or five years ago. Now it’s closer to 6%,” says Erik Hirsch, chief investment officer of Hamilton Lane, which advises pension funds holding some $55 billion in assets. Finally, some suggest Sarbanes-Oxley has been private equity’s silent partner, driving companies away from the regulatory web that comes with public ownership and into the arms of PE firms.
Veteran dealmakers like Quadrangle’s Steve Rattner think that these heady days, in which every deal seems like a winner, can’t continue. “There is no question that a meaningful number of these deals will crash and burn,” he says. “I don’t know which deals will stumble, because they mostly look fine at the moment. But it would be a complete historical aberration for there not to be reasonably significant default rates on these deals.”
For now, though, even the whiff of private-equity interest can goose a company’s stock. Consider 3Com, which surged 15% on one October day on rumors that the tech company was a buyout target–this despite the fact that analysts doubted a deal would happen and that 3Com’s ongoing cash-burn problem made it an unlikely takeover candidate.
So what’s in store for PE? FORTUNE canvassed the experts to find out what they’re expecting in 2007
What sectors will be hot?
Where PE once focused more on smokestack industries, now any company with high cash flows and low valuations will be in play. Sectors mentioned by multiple dealmakers include health care, pharma, financial services, and homebuilding. Giants such as Dell, Gap, Home Depot, and Unilever are now routinely bandied about as potential targets.
What about international?
Expect more activity in Asia. Firms such as Texas Pacific and Carlyle already have a strong presence there, but others, such as KKR and Bain, are reportedly raising Asia-specific funds. And the development of markets in China, India, and even Vietnam means funds now have a way to make a profitable exit from deals in those countries. With so much cash in search of so few bargains, buyout funds may take roads less traveled into Eastern Europe and Latin America.
How will the PE landscape change?
Traditional yardsticks such as price-to-Ebitda are up 20% in the past three years, according to Standard & Poor’s LCD, and price inflation is acute in middle-market transactions, says Bob Filek, a partner in the PricewaterhouseCoopers transaction-services group. But he argues that because very few funds can compete for the mega-acquisitions, firms like KKR and Texas Pacific can actually obtain better prices in the giant deals. That suggests there will be pressure on midsized PE firms.
What’s the endgame?
As PE funds look to sell companies they have taken private and spruced up, a big crop of IPOs will eventually ensue. In the end, says Goldman Sachs co-head of private equity Charles Baillie, “we’re headed for a downturn–the question is when.” But the giant private-equity funds are so larded with cash that even when one or two gets singed, and the inevitable credit pullback occurs, they’ll still have the means to make deals. This is one bubble that may end with a whimper, not a bang.
NICHOLAS VARCHAVER. Fortune. New York: Jan 22, 2007.Vol.155, Iss. 1; pg. 21
