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Mega-firms see uncertainty, low growth in second half

  • Markets recover after Brexit, but volatility remains
  • Sluggish growth shades deal-making
  • PE firms eye deals in Europe

Blackstone Group, Carlyle Group, Kohlberg Kravis Roberts and Oaktree Capital expect the unpredictability and volatility of recent quarters to continue as they contend with sluggish economic growth worldwide.

The surprise Brexit vote loomed large at the end of the second quarter, but the big publicly traded private equity firms generally managed to turn in stronger results than they did in the first quarter.

The firms said they had limited direct exposure to the U.K. and they saw plenty of opportunities to put money to work around the globe.

“The United Kingdom’s vote to leave the European Union created additional market uncertainty and complexity, especially in the U.K., but more broadly throughout the EU,” Carlyle Co-CEO David Rubenstein said July 27.

“We feel confident that for Carlyle, the impact of Brexit will be modest, assuming it does not lead to broader negative impact on global growth.”

Carlyle Co-CEO Bill Conway said revenue growth is hard to come by worldwide.

“Healthcare … is a business that continues to show reasonable growth,” Conway said. “Some tech businesses show pretty good growth. But a lot of the other parts of the portfolio — energy, industrial businesses — they are not really showing any growth. And frankly, the only way you can generate returns there is cash flow, debt pay-down and margin improvement.”

Blackstone CEO Stephen Schwarzman connected the Brexit vote to other jitters in recent quarters around China’s currency devaluation in 2015, followed by the worst start for equities since the Great Depression in early 2016 and chaos in debt markets. Then, the S&P 500 hit all-time highs early in the third quarter.

“We have been going through an extraordinarily strange period recently,” Schwarzman said on July 21. “All kinds of odd things are affecting markets generally and are presenting what we expect to be very interesting investment opportunities.”

Schwarzman said the firm remains active in real estate, energy and credit investments.

“Limited partner investors are seeking better returns and less volatility in this challenging environment,” he said.

“Current very low interest rates globally, coupled with high market valuations in many areas, means that many LPs simply can’t earn satisfactory returns with their current portfolios and are increasingly looking for the types of investment solutions that alternative managers can offer.”

Schwarzman said the firm’s gross returns in credit ranged from 7 percent to 10 percent in the quarter and that the performance was “shooting the lights out” compared with similar benchmarks.

Blackstone Chief Operating Officer Tony James said that in the U.S. the firm has shifted its focus toward companies that offer organic growth but with capital needs that represent a lower percentage of free cash flow. It’s also seeing “a ton” of opportunities in the energy space.

Scott Nuttall, head of the global capital and asset management group for KKR, said the firm’s pipeline remains full. Its activity level is increasing, with an eye on helping European banks with their balance sheets.

“There are a lot of interesting opportunities across Europe,” Nuttall said on July 26. “I would expect U.K. activity to be down. In the U.K., specifically, we are going to be cautious. We frankly don’t think that valuations have come down to reflect the uncertainty in the market.”

KKR is finding opportunity in Europe to “work with banks … to help them with some of the assets that they have,” Nuttall said. “We are spending time in real estate. We see opportunities in private equity on the Continent in particular.”

Bruce Karsh, co-chairman and chief investment officer of Oaktree, said Brexit did not generate the buying opportunity in distressed debt that the firm initially anticipated.

During the final days of the quarter, the British pound fell to a 31-year low against the U.S. dollar and equity markets tumbled, but the reaction in credit markets was relatively muted, he said.

“We still see European nonperforming loan pools as an important part of the opportunity set,” Karsh said on July 28. “We continue to be active purchasers as banks look to rebuild their balance sheets. … We are pleased to see multiple continental European bank sale processes ongoing.”

Action Item: Blackstone Q2 earnings, http://bit.ly/2a2EMPp; Carlyle earnings: http://bit.ly/2ae3N5V; KKR’s results: http://bit.ly/2a5hbKM; Oaktree’s earnings: http://bit.ly/1lg44Vd;

Photo courtesy of iStock/Hayden Bird