"A number of factors point towards a more optimistic longer term position for private equity," said Richard Addlestone, a private equity partner at Walkers in the Cayman Islands. "Flexibility within financing structures should provide some refuge from current market difficulties for private equity firms. While further weakness can be expected in the short term, there are hopes for a return to pre-credit crunch levels of investment and returns within 18 months. The silver lining is that, with asset prices at current lows, 2009 could be a great year for acquisitions, but first banks need to start lending to each other and to businesses."
In addition to good deals on assets, there are a number of other areas within private equity which present opportunities for investors, according to Walkers. Heavy markdowns of between 40-60% can currently be achieved on the cost of senior debt, although there is some risk if the underlying corporations that own the debt fail. "These discounts are likely to be short-lived, so interested parties need to act quickly," Mr. Addlestone said.
Infrastructure funds, which have not been as severely impacted by the credit crisis, are earmarked for further growth in 2009, due to their role in bridging the funding gap in government budgets and their inclusion in some of the stimulus and job-growth plans of the new Obama Administration. The US$12.8 billion bid to lease and operate the Pennsylvania Turnpike is a case in point. If approved by legislators, it would be the largest highway privatisation in U.S. history.
"In the current climate, investors are responding positively to an asset class which offers both strong income flows and brick and mortar assets," Mr. Addlestone added. "Infrastructure funds also fit in very well with the medium-to-long term horizons of investors."
After some astounding growth in 2008, emerging markets are now generally accepted as a mainstream class in private equity. Emerging markets will remain attractive to investors, although perhaps not to the same extent as in recent years since their growth is slowing, though not as quickly as other markets. As an example, the Brazilian private equity market is forecasted to grow just 10% in 2009 compared to the 50% rate that has been recorded since 2004, according to Bloomberg. Some firms have also had some difficulties disposing of emerging market assets as weak stock markets complicate exit opportunities. For example, CVC Capital Partners recently failed to dispose of Singapore metal stamping company Amtec Engineering.
Interest in distressed banking assets by private equity participants and a desperate need for fresh capital from the financial sector has resulted in significant speculation about what role private equity might take in reshaping the post-credit crunch environment. With some US$320 billion of cash ready to deploy and private equity's traditional strength in adding value and management expertise, struggling financial institutions are seen as particularly suitable investment targets. U.S. Treasury Secretary Henry Paulson said in November that concerted action between the private equity industry and the U.S. federal government, using its Troubled Assets Relief Program (TARP), represents a possible solution to the faltering commercial banking system in the U.S.
"In addition to the regulatory obstacles which require significant investors in U.S. banks to register as a bank holding company, the unfortunate events surrounding recent banking ventures from the likes of TPG in WaMu have made private equity firms cautious about investing in the sector," said Vicki Hazelden, private equity partner with Walkers in the Cayman Islands. "Potential conflicts between private and public agendas can complicate partnerships with governments, while any problematic deals could generate significant negative publicity, as Cerberus has seen as the owner of Chrysler."
Secondary market activity, where private equity investors can sell interests in existing funds and remaining unfunded commitments to the fund, has ground to a virtual halt. The large number of current sellers is in stark contrast to the previously competitive phase, where premiums of 10% on notional value were commonly commanded on sales.
"As a result of the credit crisis, certain over-allocated investors are looking to transfer their entire commitments in some funds. This clearly demonstrates what the industry is up against and how cautious investors are being," said Richard May, a private equity partner in Walkers' British Virgin Islands office. "Expectations of both buyers and sellers need to realign for the secondary market to begin functioning again, but there might be some bargains in the meantime."
"As the financial crisis continues to play out, the private equity industry will undergo significant change, although whether we will see a wave of consolidation and/or the emergence of a completely new model will not be clear until after the dust has settled," Ms. Hazelden said. "By demonstrating in these difficult times that it can make a difference by bringing management expertise to the table, private equity has a key role to play in reshaping the financial landscape."
