Is this latency just a return to the basic premise of the asset class or have the dynamics of private equity changed completely?
The years between 2005 and 2007 saw heady investment in private equity, coupled with fast exits and assets being held and sold over short periods of time. Much like investors in most asset classes, those with allocations to private equity came back down to earth with a thump as this cycle came to an abrupt halt.
Tim Green, managing partner at GMT Communications Partners, a private equity firm focused on the communications sector, says: “There is no question that there was a sharp reality check in the private equity market.”
Those who put money into private equity and were looking for a quick getaway, as had happened in the bubble years, were sorely disappointed. But maybe that’s a good thing for the sector since private equity was never meant to be about making a quick return. The sector offers a long-term, illiquid investment and the market may have lost sight of this.
Helen Steers, partner at Pantheon, says: “Unrealistic expectations crept in over the bubble years, but, really, private equity is about operational improvement to raise the value of the company backed or acquired.”
Having exits brought to a virtual standstill for almost two years could see some investors getting anxious. In some cases this may be understandable, but Tycho Sneyers, partner at LGT Capital Partners, says: “If investors are getting impatient because it takes a long time to see realisations, they need to understand that private equity is a long-term asset class. The realisations that are starting to take place now are typically from vintages that are six or seven years old.”
And it’s more of these realisations that people need to see for belief in the asset class to stop flagging.
Steers, at Pantheon, says: “Some profitable exits and IPOs will definitely restore confidence in the sector, but investors need to come to terms with the fact that, in private equity, there are seldom quick exits.”
Justin Partington, commercial director at fund administration firm Ipes, says: “There’s been a return to good, old-fashioned making money the hard way, through driving operational improvements and top-line growth. Portfolio investments need more work to gain the same level of return.”
David Williams, investment funds partner at law firm DLA Piper, says: “Realisations would buoy up confidence and may lead people to commit more money to the asset class, thus making it easier to raise funds, which has been challenging in recent times.”
John Gripton, head of investment management Europe at Capital Dynamics, says: “Investors want to see capital flowing back in the second half of this year and this will be very welcome.”
But private equity clients need to be wholly aware of what the investment entails and not be fooled by the bubble years of quick return.
Gripton says: “The years between 2005 and 2007 were not normal. They were the abnormal period and so cannot be used as a benchmark.”
Not everyone feels that this period was detrimental to the fundamentals of private equity investment.
Williams, of DLA Piper, says: “You can’t say that the years between 2005 and 2007 were bad for private equity investors simply because there was a lot of activity. Turnover fuelled by excessive leverage and churning may not have been right, but you cannot generalise.
“In a number of cases, there were deals being done quickly, but which were appropriate just the same. An exit after a relatively short period of time is not necessarily automatically unsuitable.”
We all know that quick exits are now a thing of the past. David Currie, chief executive of SL Capital Partners, says: “There has been a two-and-a-half-year hiatus on realisations and investors began to get impatient. But it’s our job to show them that the underlying portfolios of the funds we’ve chosen are stable. The realisations in terms of money multiples and valuation uplift have been comparable to pre-crisis returns.”
But how long are people willing to wait?
Although any investor worth their salt is aware that private equity isn’t about getting rich quick, there’s so much they’re willing to take and some are clearly getting anxious.
Williams says: “Investors would like to see cash coming back and there will be some pressure on funds to provide this. Some investors, perhaps smaller ones in particular, might be prepared to take a hit on value to see an exit. But this will not be the norm, and I would expect larger institutions, who can afford to wait for the right time to exit, to favour managers who can deliver maximum value.”
The beginning of the year had begun to seem like that “right time”.
Currie says: “Realisations started coming back at the beginning of the year but tailed off again because of the market correction in the spring. There are now signs that some activity is beginning to come through – overall things are picking up.”
According to Sneyers, certain investors hit difficulty as a result of only buying into the large or mega buyout funds, which mainly play in the IPO market, which is in turn correlated to global equity markets.
Sneyers says: “There haven’t been too many exits coming through from the larger funds. The IPO market has been difficult. Some investors in this segment of the market have gotten impatient and are selling their exposure on the secondary markets. This is because they recognise that they made a mistake by solely having exposure to these mega-funds and are now trying to remedy that by reallocating the proceeds from those secondary sales to middle market funds.”
Partington, at Ipes, says: “Investor patience depended on what they needed the cash for. Banks and some high-net-worth individuals in private equity were feeling pressures due to the denominator effect and over-commitment to PE. Family offices, on the other hand, appeared to be the most long-term, and consequently patient, type of investor in private equity.”
According to David Silver, co-head of European investment banking at RW Baird: “Rather than impatient, I think investors are somewhat frustrated but they recognise that the last two years have been difficult.
“Although we might see a few deals where investors are willing to take a hit on value, I don’t think fund investors are putting funds under pressure to behave irrationally.”
But what is going to push things forward?
In its 2010 global private equity watch, Ernst & Young says: “Private equity-backed exits are on the rise. Globally, there were 104 trade sales through 29 March 2010, including some high-profile secondary sales in Europe, compared with 78 for the full first quarter of 2009. While there was one IPO in the first quarter of 2009, 22 IPOs were listed in the first three months of 2010. Should this momentum continue, private equity exit activity in 2010 will end the year significantly higher than in 2009.”
Data from Preqin also shows that exits are on the rise. The firm says: “During Q2 2010 there were 140 private equity-backed exits with an exit transaction size of $42bn [€31bn], a 57% increase in aggregate exit size from the previous quarter, where 136 exits with an aggregate exit transaction value of $27bn took place.
This level of exit activity makes it the most active quarter for exits in the post-credit crunch landscape.”
Steers, at Pantheon, is also seeing an increase in exits. She says: “We’ve started seeing a pick-up in exit activity. There was a flurry of exits at the beginning of the year with a number of deals into the IPO market but now a lot of companies are looking at alternative exit routes.” She says that trade sales and secondary buyouts are now more certain than IPOs as an exit route in volatile markets.
Green, of GMT Communications, agrees: “Secondary deals are at their highest level ever because people are looking to sell investments to give their investors cash back and other private equity funds are looking to buy in order to have some deal flow coming through.”
Gripton, of Capital Dynamics, says: “Everyone had thought that in the absence of debt, secondary buyouts would be very difficult to execute, but surprisingly, several have been completed in recent months.”
But some believe the secondary sales market is limited.
Partington, of Ipes, says: “Secondary deals didn’t materialise as expected. The deals just were not done as the pricing expectation gaps took longer to close than expected, intersecting in late 2009 and now that the global economy shows tentative signs of improving, exits through secondary deals are not looking as attractive.”
Williams agrees: “IPOs are, most likely, still going to be a more attractive exit channel, especially as capital market performance improves.”