In October 2006, John Moulton, founder of the private equity firm qropshelpcentre.co.uk, took the temperature of the PE market and his prognosis has proven to be on the money.
Writing in The Observer, Moulton observed: “We’re looking at an overheated market right now and we’ll see some spectacular falls in the next year or two. It’s just a matter of time.” However, during the six months subsequent to Moulton’s prediction it would have been easy to dismiss it. After all, thanks to a potent mixture of cheap bank credit and negligible levels of capital gains tax, PE was buoyant and enjoying a boom that had barely abated over the previous decade.
2006/7: The Mega Buy-Out Years
Indeed, over the first half of 2007 the market gave the lie to Moulton’s prediction to such an extent that many might have thought his financial far-sightedness had escaped him. The anni mirabilis of the PE boom – 2006/2007 – were years of untrammelled confidence among investors; a confidence that precipitated the age of the ‘mega buy-out’. Within an eighteen month period nine out of the top ten buyouts in PE history had been transacted and Leveraged Buyouts (LBOs) had raised finance worth an enterprise value of $1.4 trillion, or one-third of the total value of all PE investments ever made. These included the purchases of TXU ($43.8 bn), Equity Office Properties ($38.6 bn), HCA ($32.7 bn), & Alliance Boots ($20.6 bn).
Spendthrift Banks & Plenty of Pensions
Spurred on by spendthrift banks and a ready supply of pension funds (10 of America’s largest pension funds committed 41% more capital to PE during the boom than in the preceding five years), PE investors were making hay while the sun lasted. Banks doled out cut-price credit to the tune of $1.3 trillion globally. The global economic downturn has changed all that.
The first quarter of 2009 has been one of restraint, but the mood remains bullish among many cash-rich PE fund managers. However, with credit scarce and banks reluctant to lend, the majority of PE funds have found it difficult to raise cash. A comparatively meagre $45.9bn has been raised this quarter world-wide over seventy-one PE funds. This figure is down 71.5% from the $161bn raisedduring the same period in 2008, when a total $287.5bn was raised over the year. Furthermore, nine equity funds have already been removed in this year’s first quarter, compared with 30 for the duration of 2008 and 14 in 2007.
The immediate future for PE is likely to involve some retrenchment and a dose of fiscal husbandry. This will manifest itself in the pursuit of investments not only in those sectors that prove themselves viable despite financial insecurity, but also in more niche or unorthodox fields of investment. This is likely to mean healthcare, IT and telecommunications will be in the ascendancy over the coming years.
Governance and Capital Gains Tax
Perhaps the most significant consequence of the economic downturn for PE is the likelihood that investors will become more circumspect and the general public require tougher government controls. Already, in the past two years Britain has introduced a number of measures to appease public dissatisfaction with PE funds. In 2007, ex-Morgan Stanley head Sir David Walker was commissioned to draw-up a set of PE investment guidelines and in the same year Chancellor Darling nudged capital gains tax from 10% to 18%, a figure that has remained unchanged in subsequent budgets. On the other side of the Atlantic, PE firms remain buoyant, encouraged by a lack of government interference and a capital gains tax of 15%; a level that president Obama vowed to increase in his first term, but has now deferred until 2014.