Bankers, regulators and politicians are behind the curve. They are like workers rushing to clear up a car crash armed only with aspirin and Band-Aids: too late on the scene, and not able to do much when they get there.
The next phase of the credit crunch, and quite possibly the ugliest as well, is plain to see. The leveraged-buyout funds have loaded up too many companies with too much debt at the wrong prices. They are like planes in the air with no fuel left in their tanks. Crashes are inevitable.
Private equity needs to be fixed now, with refinancing, stress tests, and government stakes if necessary. There is no point waiting until it is too late. The pain is evident in the shares of the publicly listed funds. Blackstone Group LP, the world’s largest quoted private equity firm, has slumped to about $5 (Rs259.65) from more than $30 in 2007. Last week, it reported a fourth-quarter loss of $827.1 million.
In the UK, 3i Group Plc has dropped to less than £2 (Rs145.6) from £11 in late 2007. Shares in Candover Investments Plc are close to £2 after trading at more than £22 last year. The company has scrapped the dividend and said it will cut jobs. Kohlberg Kravis Roberts and Co. said this week the value of investments in its publicly traded buyout fund fell 32% in the fourth quarter.
Six months ago, the slumping share prices of many banks were sending clear signs of trouble ahead. Buyout funds are emitting the same distress signals now and it is hard to believe there won’t be a lot more pain, just as there was in the banking industry.
Private equity was partly about reinvigorating tired and lazy management. In fairness, it often did that job a lot better than many gave it credit for. It was still mostly about re-engineering balance sheets so they supported more debt. With loans evaporating, many firms will run into trouble.
Typically, buyout funds liked to purchase big companies in solid industries, the kind that employ lots of people. It doesn’t matter that much when a few bankers lose their bonuses. If businesses controlled by buyout funds collapse, tens of thousands of people will be thrown out of work.
First, the buyout funds need to start restructuring their deals now. There is no point waiting until the last minute. If this is the deepest recession since the 1930s, only businesses with rock-solid balance sheets will pull through. They are going to need cash in the bank. And they will have to be in strong enough financial shape to borrow more if necessary. Not many private equity-owned companies fall into that category. They need to start working on that immediately.
Next, regulators have to stress test every major private equity deal of the past three years. Buyout firms bought a lot of companies at the top of the market. In many cases, the bondholders will have to swap debt for equity, and that equity is probably going to fall in value. That is just tough. The bondholders will lose money anyway. They might as well not take businesses down with them. But the regulators need to knock heads together now so they accept that.
Lastly, governments in the US, the UK and elsewhere may need to step in. Where there are problems restructuring debt into equity, there may be no alternative to government stakes in businesses, even if only for a short period. The state may end up owning shares in some odd-looking enterprises. Yet even six months ago, we wouldn’t have thought such a situation was possible with many big banks. It is better than doing nothing.
We hear a lot of rhetoric from governments around the world about what they are doing to cope with the crisis. Unless they are willing to get ahead of the curve, it is mostly just hot air. Fixing the private equity bust is the place they should start.
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