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Private Equity - Summer Fizzle

By: Marc Raybin - Date: 09/10/2007

Just because the summer is coming to a close and cooler weather on its way, it does not mean private equity will go cold. In fact, despite the recent turmoil in the credit markets caused by the subprime collapse, more than a few people think private equity will continue to stay hot.

The asset class may not be red hot as it had been in the last year or so, but it should continue to turn out profits for the foreseeable future. To be sure, private equity is not immune from the ebbs and flows of the economy at large and has to adjust to an ever-changing climate.

Dean Mills, a partner with PA Early Stage, says the credit crunch is pushing buyout investors toward his end of the marketplace. He says investors who put all or a majority of their money into the buyout space are realizing the time is right to put some of that capital to work on the venture side. Mills says the buyout world has been having venture-like returns in the last few years and that is changing.

“They have come to the realization that what they thought was a gravy train in the buyout market is not as stable as it once was,” explains Mills. “Many parked all of their money there, but they are noticing now, and more so [that] in the future, you willneed diversification.”

The same can be said for investing in the middle market. As the big boys at the top of the totem pole are finding the going increasingly tougher, investors’ attention should be pulled toward the middle of the market.

“We are not seeing liquidity issues that you are seeing at the top end of the market,” says Michael Turner, a partner at Farlie Turner & Co., a mergers and acquisitions boutique firm. “Middle market financing sources are still doing deals.”

Ironically, as investors continue to move toward the middle market where deal flow may be a bit easier these days, prices are starting to goup. Turner says pricing on deals has gone up anywhere from 50 to 75 basis points while leverage
has declined half a turn to three quarters of a turn, further evidence of private equity not being immune to the vicissitudes of the economy as a whole.

Venture and the middle market are not the only areas that may see an uptick in attention as the mega-dealers’ going gets a little tougher. J. Lyons Brewer, a partner with placement agent C.P. Eaton Partners, says that while a lot of recent attention has been paid to the shrinking credit market, private equity interest in Asia continues to be strong. In fact, he knows of there being between 300 and 400 limited partners planning to invest in those markets, particularly in China and India. That includes a variety of investors, such as endowments, state pension funds, etc. Brewer says Asia is just as strong now as it was in recent history and will continue to be so. He says it is still very much a growth market.

Brewer is also bullish on private equity investment in Europe. He says the buyout business and fund raising numbers in the European Union have exceeded those in the United States.

Getting back to the U.S., when it comes to the buyout market over here, Brewer’s sentiments seem to echo those of Turner and Mills. With the easy credit in the U.S. buyout market for large deals slowing down, the pressure is on buyout firms to differentiate themselves from the rest of the pack.

“You better have a really competitive, compelling product because it is very difficult to get on the agendas of limited partners with a ‘me too’ [strategy],” says Brewer.

Investors should not bet on being able to find a diamond in the rough when it comes to sectors in the U.S. buyout market that will not be hit by the credit crunch. Turner
speculates that all will most likely feel the pain.


“The credit markets really did not discriminate in terms of their willingness in offering leverage,” Turner says. “Some industries have always been more appealing from a leveragability point of view, but I would say across the board, the credit markets were very generous in lending for transactions in all industries.”


Only time will tell just how the credit crunch is really going to effect private equity, but it is safe to say that at the very least, the asset class is in the throws of major shifts. The odds are pretty good that the number and the size of mega deals will decrease and as investors look for new areas to park their money, offerings in the middle and lower end of the market will see increased attention. An important question, of course, is whether or not the middle market will become a victim of its own success by raising the prices of deals too high. Having said that, the market does have a way of right-siding itself when needed. 

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