The new year didn’t come fast enough for buyout firms. In 2008, deals imploded and portfolio companies went bankrupt. It was nearly impossible to sell a company and cash-strapped investors started whining about capital calls. Problems cropped up throughout the business.
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Unfortunately, buyout bosses don’t have much to look forward to this year. Debt markets aren’t likely to rebound much. Restructuring opportunities might pop up, but traditional leveraged buyouts (LBO) will be scarce and difficult to pull off. And many buyout firms have to repair strained relationships with their bankers and investors.
In fact, LBO business has screeched to a near-halt. Deal volume fell around 70% in 2008 from the prior year’s levels, according to Dealogic. Buyout firms only sold companies worth around $6 billion (Rs29,040 crore today) in the fourth quarter, a tiny fraction of the $110 billion of sales seen in the second quarter of 2007, at the peak of the boom. Portfolio companies started to succumb to the economic malaise and credit crunch. Several big-name LBOs toppled under the weight of their debt and went bankrupt, including Linens N Things and Tribune.
The slowdown in new deal activity was mostly due to the frozen debt markets. This, along with plummeting equity markets, made it difficult to sell portfolio companies. Most economists don’t think either market will rebound significantly this year. So, deal volumes will probably remain anaemic.
Some private equity firms might try to keep busy buying troubled companies on the cheap. Or they could partner with strategic buyers on mergers. But neither type of deal will keep them busy enough.
Even if private equity firms want to snap up distressed companies, they might have trouble getting financing. Their investors are running short on cash. In the US public pension funds segment, if other asset classes don’t rebound, pension funds seeking to keep their portfolio allocations stable could be forced to sell more buyout investments at big discounts.
This year may be worse. Valuations of private equity investments tend to lag others, since they don’t need to be valued on a market basis each quarter. So, investors may endure drastic drops in their portfolio valuations well into this year from losses made in 2008. Even if things rebound, before a raft of new deals can struggle to market, private equity firms will need to repair their relationships with banks.
Deal fees, in particular, could become a point of contention. Buyout shops collected nearly $400 million, in total, for the acquisitions of Harrah’s Entertainment and Freescale Semiconductor. They typically pay some of that cash to investors, but also take a big chunk for themselves. Both those companies are struggling. If investors end up losing money on aggressive deals where buyout managers made big deal-fee windfalls, they will question managers’ motives as well as their judgement.
Publicly listed private equity firms are even worse off. Their increasingly aggrieved shareholders limit their flexibility. They don’t have the luxury of closing shop for a while or making concessions on fees or investor funding commitments. That’s in addition to the daily embarrassment of their battered stock prices.
The financial crisis has taught the buyout barons, who strode the earth a mere 18 months ago, important lessons in humility. Their education will no doubt continue in 2009.