The heads of three of the largest private equity firms in the world expressed optimism that 2010 will be a stronger year for acquisitions and for sales of companies already in their portfolios.
However, in interviews with Reuters while attending the World Economic Forum in Davos in the past few days, they had varying views over whether the size of deals could start to head back up to the $10 billion mark, or even above, from the post-financial crisis limits in the $3 billion to $5 billion range.
David Rubenstein, the co-founder of Carlyle Group, said he sees all the four key metrics for the business taking a “fairly dramatic move in the right direction.
“More deal volume and value, much more on distributions, much more in terms of fund raising,” he said, adding that the valuations for private equity holdings had now risen for four successive quarters.
During the financial crisis, private equity firms were largely locked out of the credit markets making it tough for them to finance leveraged buyouts, while the equities markets were so weak that initial public offerings of existing investments became very difficult.
However, in the past six months the credit markets have opened up more, at least for small or medium-sized deals, and the recovery in stock markets has made IPOs achievable once again.
Stephen Schwarzman, chief executive of private equity giant Blackstone Group, said that typically the first year of economic recovery after a recession has been a good one for making private equity investments. “Historically, the returns have been double or triple what they were at the top of the economic cycle,” he said.
This time may be a bit different because the economic recovery is likely to be more muted than after previous downturns, which means the firms may have to hold the investments longer to make the same returns, he said.
Henry Kravis is also very optimistic about this year’s outlook.
The legendary co-founder of Kohlberg Kravis Roberts & Co, said that the environment was certainly better than last year.
“Clearly markets have opened up, the debt markets are open right now, the bank loan markets are just opening, spreads have come down tremendously, so your cost of capital comes down. And the equity markets are open so it now makes it possible for companies acquired in the last years to go public,” he said.
He also said that larger leveraged buyouts of the $10 billion range could return. “I wouldn’t discount anything right now. I think there is that possibility — they would require more equity so you have to find out where the equity is coming from. I am not going to guess whether they are 8 billion or 10 billion or 5 billion, the capital markets being open enables larger deals.”
The “sweet spot” for most firms would be in the $1 billion to $3 billion range though, he said.
The need for more equity in deals is one of the lasting legacies of the crisis. There is also an even greater increased focus on running businesses well rather than relying on financial engineering.
“The valuations have come down and the leverage has come down but that is a small piece of what has to happen — you have to have the operational improvement in a company and that is how you make money today,” said Kravis. “You have to act and think like an industrialist, if you are just going to do financial engineering you are not going to be around long.”
Rubenstein says he doesn’t see the size of deals climbing. “I think you will probably see deals in the $2 billion-$5 billion range — I don’t think you will see pure buyouts in the $10 billion, $15 billion, $20 billion or $30 billion category.”
That doesn’t worry him though. The rules are different after every recession, he said.
“This time you are seeing smaller deals, smaller funds, higher equity components in the deals, more minority stake transactions, much higher co-investments by investors, fewer consortia deals by private equity firms and much more money being put in emerging markets and more government oversight and interest in what private equity is doing,” he said.
All three say they expect to probably do more IPOs this year than last, though they also declined to give specific forecasts. Rubenstein said that Carlyle itself has no immediate plans to join Blackstone as a publicly traded company.
“We are not today planning to go public this year, we have a lot of things we are going to do and we think we can do these things as a private company. We will take a look at the situation down the road,” he said.