Are the halcyon days of private equity over?

With debt financing tight, private equity houses will have to focus on the operational performances of the companies they have bought in the past few years.

They can no longer rely solely on refinancing and Ebitda bolt-on growth strategies to obtain the high returns they became used to during the good times.

Target companies are just not out there in the same number that they were during the heady feeding frenzy days of 2006 to the first half of 2007. That was when debt was easy to obtain and cheap.

Strategic players were happy to sell assets at expensive prices to private equity. Then came the credit crunch. The global economy has deteriorated drastically in the past few weeks.

“In the current environment where deal flow has reduced, now is an ideal time for a period of introspection in which to take a look at the portfolios that have been built over the last few years and to identify ways to generate the most value from them,” says Phil Dunne, a partner at consultancy firm AT Kearney and head of its UK transaction services team.

In fact, it has recently emerged that private equity houses are now hiring internal performance people to improve the running of their portfolio businesses.

Interestingly, AT Kearney found that average returns on equity from investments made by private equity funds between 2004 and 2007 were an impressive 57%, with exit multiples of around 17x in 2007 – the peak of the market.

In a toughening economic environment, however, exit multiples are likely to fall. Private equity houses would therefore have to substantially grow the Ebitda (which has averaged out at 8% year-on-year since 2004) for each of their portfolio businesses to maintain their high returns on equity.

If exit multiples were to drop by 20% because of a significant downturn in the market, Ebitda growth would have to rise from 8% to at least 22% – an increasingly difficult feat in today’s market.

The halcyon days of private equity are over; but Dunne remains confident that the industry can adapt to a more hands-on operational approach rather than one that is simply deal-driven.