Digging for gold
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15 August 2011
Private equity is having to dig deep and explore all avenues during these testing times. Richard Addlestone provides an insight into the current market
Nine months on from the meltdown in financial markets, and amid the most challenging period to date for the private equity industry, there are some interesting indicators for activity for the remainder of 2009. And being part of an offshore legal practice in the Cayman Islands provides an opportunity to gain a broad overview of current market trends.
The statistics are sobering, with private equity dealflow in the first half of 2009 at a 17-year low, according to Thomson Reuters’ data. Year-to-date deals totalled $22.4bn (£13.83bn), which was down 82 per cent on the first half of 2008. At $10.4bn in the second quarter (Q2), global private equity deals were the lowest on a quarterly basis since Q4 in 2001.
There is no doubt that these are testing times. However, the news is not all bad and there are some opportunities on the near horizon.
Spreading the net
Despite the poor figures, Middle Eastern sovereign wealth funds (SWFs) are still considered a key source of funding. Recent losses have made them more focused on investing in the Middle East and North Africa (Mena) region, but there is still appetite for investing in non-Mena funds.
Emerging markets are still considered a growth area, possibly the only one given the economic crisis, with their economies seemingly the only ones growing these days, albeit at rates far reduced from before the crisis began.
Although volatile, the mining sector is attractive to private equity houses, according to comments made at a recent conference by Warren Gilman, managing director and head of CIBC World Markets, Asia-Pacific. The entire mining industry took in $12bn in new equity in Q1 2009.
Public private investment partnerships
One of the latest potentially key developments for the private equity industry was the launch of US Treasury Secretary Tim Geithner’s ‘public private investment partnerships’ (PPIP) programme on 23 March. This is widely seen as being a good opportunity for private equity houses. PPIP would provide federal funding to form PPPs, which would buy up toxic loans and securities from ailing banks with the intention of removing them from banks’ balance sheets so as to kick-start them into lending. Several private equity firms, including BlackRock and Oaktree Capital Management, have been chosen by the Treasury to participate and have 12 weeks to raise at lease $500m in capital. The main question is whether banks would be willing to sell their marked-down loans given the possibility of green shoots on the horizon, and so rising values.
Let us not forget the context in which these potential opportunities exist.
Due to the general lack of bank finance, there is scant ‘conventional’ private equity activity going on, as firms have little, if any, ability to use leverage. The focus is perhaps more on saving deals than making deals.
In a recent press interview, Leon Black, chairman and chief executive of private equity house Apollo Management, indicated that his main priority was to stabilise his company’s existing portfolio of investments to preserve the benefits for existing investors. He sees great opportunities in distressed assets, but only where general partners have the requisite skill sets (as does Apollo).
Distressed debt is a potential growth area for two reasons. First, it requires no new financing (which is not available) and instead involves working with creditors to restructure. Second, the debt being restructured, if initially placed in 2006-07, is covenant-lite and so is quite likely not to be in default. In a timely move, the Cayman Islands recently enacted changes to its Companies Law to permit Delaware law-style mergers and consolidations of Cayman companies. This will assist clients with their restructuring efforts.
Although deal numbers are down, they are still being done. There is tough competition for the few good deals that are around, putting upward pressure on pricing. The level of secondary market activity is starting to boom and bargains are plentiful as liquidity problems start to bite hard. Assets from floundering private equity houses are starting to come into the market.
JP Morgan Private Bank recently entered the private equity secondary market, raising approximately $500m for a new fund. In an interesting move, Probitas Partners is apparently looking to pair sovereign wealth funds (SWFs) with cash-strapped investors in such a way that the SWFs take on the obligation to fund future capital calls. This leaves investors still able to benefit from the upside of their invested capital and avoid making big losses by selling at a huge discount in the secondary market.
Predicting the remainder of 2009 for private equity is difficult. Looking at history, the highest-return deals are undertaken at the worst of times, and there is little argument as to where we stand now.
Richard Addlestone is a partner at Walkers