Private equity coming back, or not?
There were two stories in The Wall Street Journal on Tuesday about the state of the private equity industry. The problem is that the two stories seemed to contradict each other.
First, there was the piece in Ahead of the Tape:
What seems likely, though, is that there will be plenty more deals if current, unique conditions persist. A buyout binge may fall short of that seen in 2007 but not by much.
The difference, or spread, between yields on Treasury debt and rates for high-yield bonds isn’t as small as in 2007. But the absolute interest rate of high-yield debt is near a record low.
That is because the yield on Treasurys is so much lower today, largely thanks to a superaggressive Federal Reserve. And, notwithstanding a recent retreat that saw large outflows from some popular high-yield exchange-traded funds, individual investors remain desperate for income.
One might think the other side of the equation, investor cash in private-equity funds, is lacking. It isn’t. From 2005 to 2007 alone, some $1.6 trillion was raised by the industry, according to Dealogic. Much of it never got spent. Now fund managers facing a “use it or lose it” situation have an incentive to get deals done.
The confluence of low interest rates, private-equity investors with money burning a hole in their pockets and what remains a decent economic outlook should keep the deals flowing.
But, as past buyout booms have progressed, the deals have gotten sillier: a lower equity contribution, higher valuations and less margin for error.
This one has yet to get started. If the pattern holds, however, the time will come when stock investors should be only too happy to sell. And some of those piling into high-yield debt, or even relatively sophisticated investors with money in private-equity funds, will again make investments they live to regret.
But then, there was the Current Account column, which said just about the opposite. Here are a few clips about that opinion on the state of the buyout market.
The credit boom of 2005-2007 supercharged this trend. As banks and investors fell over themselves to provide financing for takeovers such as the $45 billion purchase of the Texas power producer TXU Corp., deals got bigger and more daring.
That emboldened private-equity executives to raise ever-bigger funds and lured newcomers into the sector. From 2006 to 2008, private-equity funds raised more than $1.8 trillion, nearly three times as much as in the previous three years, according to Preqin.
The financial crisis ended that streak. And the ensuing economic downturn shellacked many of the debt-laden companies acquired in boom times, making it difficult for private-equity owners to sell them.
The freezing of M&A and capital markets ushered in an era of private-equity hibernation. Larger players like Blackstone Group LP and KKR & Co. diversified into less cyclical areas like hedge funds and asset management. Most of the others struggled on.
The postcrisis stasis is also affecting the supply of available companies. Many struggling funds still own the companies they bought in the 2005-2007 deal binge and may be tempted to pad their return numbers by unloading them.
As for debt, the junk-bond markets that feed buyouts are open and rallying, but banks and investors have been reluctant to let private equity use as much debt as before the crisis.
Those planning the next big M&A bash should bear in mind that there might be fewer, and more sober, private-equity guests.
So buyouts are back? They’re not back? Private equity titans are going to make bigger and riskier deals? Or there are going to be fewer, more thoughtful ones?
After reading this, I’m more confused than ever about the state of the market.