IF ASKED TO SUM UP THE CURRENT SENTIMENT in the private equity market, we would say it is one of cautious optimism. Private equity is beginning to emerge from the dark shadows of the recession and to reassert itself on the world stage, albeit with some changes. Evidence from the increased number of private equity deals being done and the availability of debt support this. This message of cautious optimism is one that clearly surfaced at the recent private equity event that Hogan Lovells hosted with Real Deals.
Discussion quickly turned to debt availability, where we have seen lenders move from their 2008 position of up to 3x Ebitda to up to 5x Ebitda today. Similarly, we have seen a shift from a limit of £20m (€22.5m) to £25m for a bank to much higher figures today, although the overall amount available for lending is still around 50 per cent of total deal size. There has also been increased competition between banks for the debt portion where large amounts of debt are needed on big deals, as banks have returned to the market and have to compete with the high-yield market, specialist credit funds and other specialist debt providers. Although there is greater competition among debt providers, enabling the very largest private equity deals to be considered and carried out once more, the bad news for private equity is that this has not favourably impacted debt pricing. Debt margins remain stubbornly high, with margin structures in the 4.5 per cent range rather than the 2.5 per cent range seen pre-crisis.
In addition to increased margins, the inability to put more leverage into transactions means there is reduced ability for private equity to make a return based on high levels of leverage than was the case in the past. Although one would expect these constraining factors ultimately to have a negative impact on returns, our panel were of the view that this would not stop the private equity asset class from outperforming other asset classes and delivering 20 to 25 per cent returns in the future.
Apart from debt considerations, it is notable that very few private equity deals of significance were transacted from the start of 2008 until the final quarter of 2010. This hiatus has now led to a massive amount of “dry powder” sitting in European private equity funds (US$138bn at the end of 2010 according to Preqin), a lot of which will need to be spent over the next two years. There have also been very few meaningful exits in this period. This pent-up demand among private equity firms to exit and to spend before their fund investment window closes is very real. Enabling GPs to go out and raise new funds, justify their fees and not have to return money to investors, has led to a “bubble” of money sitting there just waiting for the right opportunity.
The danger of this “bubble”, of course, is that private equity may end up overpaying for assets, just to get money out of the door. That was not, however, the view of our panel, or our private equity audience, and it does not accord with our own experience of advising private equity clients, who remain disciplined in their approach to investing. Signs that confidence is returning to the world of private equity can be seen in the increasing number of private equity exits and larger deals being done since the last quarter of 2010. The challenge for GPs will be to maintain this discipline over the next two years, as increasing numbers of private equity players with lots of equity firepower and the ability to get hold of greater leverage from debt providers compete with each other and trade players for quality assets.
