Private equity is a mature asset class that is enjoying an
excellent fund raising cycle. According to Prequin, 1Q15 fund
raising topped $104B just $7B shy of a very robust 1Q14. Continued strong
equity and IPO markets allowed PE funds to liquidate portfolio holdings at
attractive prices and return substantial capital to their limited partner
investors. These investors may be chasing yield based on past performance by
reinvesting in new funds. For example, they committed $17B to Blacksone's
latest fund in just 7 months, among others.
Strong fund raising combined with weak investing prospects have raised the level of PE dry powder to over $1.2T (that is in trillion not
billion). PE investments both in number and dollars (excluding the hybrid
3G-Berkshire Hathaway Heinz-Kraft $40B deal) have fallen to their lowest level
since the crisis year 0f 2009. PE is being out-bid by strategic acquirers in a
buoyant M&A market. Thomson
Reuters reports that domestic
M&A is up by over 30% 1Q15 to over $415B-heavily skewed towards larger $5B+
deals. Furthermore average purchase price multiples top 12.5X EBITDA with
premiums in excess of 37% in an already frothy stock market.
Remember, PE adds value in one of 4 ways:
1)
Buying Right (i.e. not over paying): this is
difficult when strategic acquirers are offering such high premiums.
2)
Financial Engineering (i.e. high leverage):
complicated by bank regulator guidance
frowning upon FD/EBITDA leverage levels above 6X. Current new deal leverage is
stuck at around 6X. The PE math (not risk adjusted) is difficult when you pay
12X and can only leverage lever up 6X.
3)
Multiple Expansion (i.e. sell high): little room
for multiple arbitrage (buying cheap in the public market and subsequently selling
higher in the M&A takeout market) at current price levels.
4)
Operating Improvements (i.e. grow EBITDA): the
easy stuff has already been done; the big payoff requires some special
strategic sauce like 3G is doing with Kraft-combining it 3G’s prior Heinz
acquisition. This is both difficult and rare for PE.
PE is a mature asset class experiencing a cyclical recovery.
GPs will have a difficult time profitably investing. Make no mistake, however,
invest it they will (otherwise they forgo substantial fees) leading to some
unhappy returns for current LPs. This is just the nature of the pro cyclical
boom and bust PE cycle. There is just too much capital to deliver superior risk
adjusted performance across the market cycles thru differentiated strategies.
The former persistence of
superior returns in certain top tier funds has disappeared suggesting just
competitive the market has become. LPs should beware of investing at this point
of the fund raising cycle.
J
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