Dealmakers wary of high prices

“We’re at a tough point in the cycle,” Kevin Conway, managing partner at Clayton, Dublier & Rice, said during at the Columbia Business School Private Equity & Venture Capital Conference March 6 at the Waldorf Astoria in New York City. “The public markets are priced for perfection. It’s a great time to raise money, (but) a really tough time to invest it.”

Conway said he had no idea if 2015 will be a good or bad vintage year for private equity funds. “We’ll know … in five to 10 years,” he said.

Turning toward the favorable exit environment, CD&R made about 5.5x its investment on its Envision Healthcare deal, which recently sold 50.9 million shares of common stock at $36.25 a share, Conway said.

With the U.S. Federal Reserve moving quickly to put liquidity into the system following the collapse of Lehman Brothers in 2008, the Global Financial Crisis “was over pretty quickly” for buyout firms, Conway said. He predicted another downturn wouldn’t be as dramatic, but would last longer, maybe seven or eight years.

Conway shared a quip from a conversation he had over dinner with Warren Buffett. “He’d rather buy a good business at a fair price than a fair business at a good price,” Conway said. 

Paul Levy, managing partner at JLL Partners, said Buffett recognizes that “a crisis is a great opportunity” when he invested $5 billion in Goldman Sachs at the height of the financial crisis.

Levy theorized that Buffett “denigrates” private equity because he wants executives “to sell him businesses at a discount” instead of shopping their companies to LBO firms. (Buffett took some shots at private equity firms in his latest annual letter.)

While Levy said he doesn’t see an economic crash coming any time soon, a drop in valuations may present buying opportunities “if you’ve done a lot of research and you’ve monitored companies you’d like to own.” 

JLL has been weighing potential deals by calculating the advantage of closing a platform investment and an add-on deal at about the same time. “When you put the two together, you get the benefits of combining them — that’s one way of doing deals in a high-priced environment,” he said. Levy singled out the aerospace business as one pricey industry, where high quality companies command purchase price multiples of 14x EBITDA.

All five panelists at the presentation, “LBOs: Managing Cycles and the Road Ahead,” said they didn’t know when the next economic downturn would take place.

CD&R’s Conway said most big buyout shop managers he’s spoken to remain more enthusiastic about selling than buying. If you’re paying a high purchase price multiple with low cost of credit, and interest rates rise, refinancing terms may not be as favorable in the future, he said. As one alternative to a traditional buyout, CD&R has invested in a number of convertible debt deals.

Justin Stevens, partner at Apollo Global Management, said it’s a good time to be patient with capital and look for complex deals that others may avoid. “That’s how you distinguish yourself,” Stevens said. “We all see this as a robust environment in terms of prices for new deals.” 

One surprise both inside and outside the private equity industry has been the sudden drop in oil prices, Stevens said. “With commodities, you have to underwrite your business while assuming energy markets aren’t going to be sky-high forever,” he said.

Andy O’Brien, managing director and global head of loan capital strategy for J.P. Morgan & Chase Co, said buyout purchase price multiples have risen, but interest rates remain much lower now than in 2006 and 2007. In another positive sign, the default rate on loans remains below 1 percent.

While the regulatory environment around leverage levels may dampen volume for larger deals going forward, interest rates will stay low compared to historical averages. While big banks may cap leverage on their deals, non-bank lenders may move in to take up the slack, he said. ”Overall, we’re pretty optimistic,” O’Brien said.