Private equity has started 2013 with a home run. Technology
czar Michael Dell has joined with Silver Lake to take
) private for $24.4 billion. This is the largest leveraged buyout
since the financial meltdown of 2008.
But the deal has already run into trouble -- most recently,
T. Rowe Price Group, Inc.
) and Southeastern Asset Management are of the view that the deal
to take the 25-year old public company private is undervalued. T.
Rowe Price and Southeastern are Dell's two largest independent
shareholders and own around 13% of the tech major. Michael Dell
holds 14%; he is the only shareholder with a larger stake than
This development is symptomatic of the trends that have come to
define private equity activity in recent times. One of the major
factors pushing up the cost of deals is that private equity
companies are flush with funds. According to research firm
Preqin, private equity buyout funds focusing on North America
collectively held idle capital to the tune of $189.4 billion as
of Jan 2013. This is just 12% lower than the amount in Dec
2011. So, a large volume of capital has piled up, which private
equity either has to utilize optimally or return to investors.
The other factor pushing up deal values has been persistently low
interest rates. Speaking at the SuperReturn conference in
Berlin, Leon Black, Chief Executive of
Apollo Global Management, LLC
) said the average price for private equity deals in the U.S. is
9 times EBITDA. One of the major assumptions resulting from such
high valuations is that interest rates will continue to be soft
over the next five years, he said.
However, Apollo has managed to strike deals at lower valuations,
around 6 times EBITDA. This has primarily happened by acquiring
corporate "hive-offs" or businesses being offered for sale by a
parent company. Together with these two factors, the lack of
growth opportunities across the globe has meant private equity
may never generate the kind of returns it has in the past.
It would still be wrong to say that private equity has completely
lost its shine. Over time, private equity has consistently
outperformed other asset classes. The Cambridge Associates LLC
U.S. Private Equity Index has an internal rate of return (IRR) of
13.7% for the ten years up to Sep 30, 2012. This is significantly
higher than the S&P 500's return of 8% for the same
However, returns are now comparatively lower. Data from Cambridge
Associates shows that the top performing 25% of U.S. funds
managers who launched funds in 2001 have to-date returned an IRR
of 36.5%. This is significantly higher than the IRR of 13.9% of
the top performing 25% of funds launched in 2004. By this time,
the number of funds had grown from 24 to 66, which shows that
returns have fallen since the number of funds increased.
The focus now seems to be on prudent financial transactions, a
far cry from the complicated financial engineering of the past.
Fund managers are now seeking out companies with a high intrinsic
value, before even attempting to turn them around. Such a
strategy is aimed at launching a second IPO, the most lucrative
outcome of a private equity deal.
Therefore, deals are evaluated with an increasing focus on
operational feasibility. This is why propositions such as
Best Buy Co., Inc.
) are viewed with skepticism by fund managers. The major concern
in this case is that the company operates in a dying industry and
a turnaround would be highly risky.
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It's not that the entire industry has reoriented itself towards a
low risk, conservative approach. Speaking at the SuperReturn
conference, Howard Marks, Chairman of Oaktree Capital, said the
slow recovery in both Europe and the U.S. has meant investors are
moving towards riskier propositions in the quest for higher
returns. Marks said the ratio of debt on leveraged buyouts is
moving towards "pre-crisis highs."
However, even in such a scenario, the U.S. is being preferred
over Europe. This is primarily due to robust earnings growth from
companies, a shale gas-fueled boom and a higher number of deals.
But overall, it is the emphasis on bargain hunting and improving
a company's operational efficiency which has made the U.S. a
standout destination for private equity. And the trend looks set