Two diverging views on the 2009 outlook for PE

It takes two views to make a market, doesn’t it? A buyer and a seller. Black and white. Short and long….

So it is with no delight that I bring you two distinct views of what 2009 has in store for the private equity world. In one corner, we have David Rubenstein, Co-founder and Managing Director of The Carlyle Group, one of the world’s largest private equity firms with US$81 billion under management. In the other, we have Canada’s own Terence Kevin O’Leary, Boss of the $40 million O’Leary Global Equity Income Fund.

The Carlyle insights come via an interview with the United Arab Emirates business journal Emirates 24/7. According to Mr. Rubenstein, 2009 “is a good time for private equity players if the industry moves carefully and skillfully with corporate partners and sovereign wealth funds. Low prices can yield attractive returns for the PE industry – perhaps the best ever.”

“An enormous number of companies need capital and the private equity industry has the necessary money. The US Government can’t do everything. Private equity players can play an important role by re-capitalising many institutions.”

Rubenstein believes that there are huge opportunities for PE. “They [PE] can invest in financial services businesses, an industry that hasn’t previously seen a great deal of PE involvement. With $1 trillion of dry powder, the PE industry is in a stronger position than anyone else to help in economic recovery by providing capital and management expertise to financial services businesses. PE can re-tool itself by coming in and offering longer-term capital to these institutions and helping them turn around,” he said.

Distressed PE has never seen so many opportunities, with one expert describing the current situation as a “once in a lifetime” opportunity. Most analysts favour investments in the US in this particular area – buy cheap and reap the benefits, they believe.

For Mr. O’Leary, this is just soooo not happening. According to KO’s buyout “friends” in California anyway, the private equity landscape couldn’t be worse.

Thanks to the Globe and Mail’s Monday edition, we are able to delve into the key reasons why the global private equity industry is collapsing around our ears, no matter what Mr. Rubenstein might say for himself. You can’t pay enough for this deep insight from KO:

“Between 25 per cent and 40 per cent of top 100 private equity firms are going to disappear in this economic downturn because they will never raise another dime as a significant number of their deals are going to underperform or worse. Go to zero.”

“What drove the explosive growth of this sector was covenant-free cheap debt. That’s over. Now many of these PE firms are loaded with portfolio companies that are way over levered. They have more debt than they can service going into a recession. These companies are going to default on their debt, and go bankrupt. As a result returns on PE funds that were launched in the last three to five years are going to be terrible. Instead of 20-per-cent annualized returns they could be negative. If you are a pension fund that bankrolled many of these PE firms you are not happy.”

“Multiples have collapsed. Between 2003 and 2007 EBITDA multiples grew by 41 per cent in public markets. That means PE guys were able to earn a good return from this appreciation without having to improve the performance of their portfolio investment. They got fat and lazy. Along comes 2008 and a 45-per-cent compression in multiples. Now selling a portfolio company with reduced earnings into a market that will not pay up will lead to a painful loss.”

Well, well, well. All these things that hadn’t crystalized for us until we read the DTM this week:

– The returns of some 2006-vintage private equity funds will not reflect traditional industry norms (see prior post “Private Equity return expectations sag” November 11-07).

– Excessive bank leverge has gone away (see prior post “‘Panic sets in to the debt markets part 2” September 17-08).

– The market is down, which makes it harder to exit deals (see prior post “Buckle up – the wheels have come off” August 13-07).

Although I retired from the professional media more than 20 years ago, I must say that the depth of these insights is certainly worth the 18 column inches of space that it consumed. One has to wonder why it has been kept from us for so long. Quite the stark difference in perspectives between Messers Rubenstein and O’Leary, but that’s why it is good to keep an eye on the papers in the Middle East.

MRM
(disclosure – this post, like all blogs, is an Opinion Piece)