Ghosts resurface

As the days shorten and the nights lengthen, as autumn gives way to winter and the year staggers to a close, a man’s thoughts become reflective in nature as he ponders upon the year’s events. For those operating in the world of high finance, the year started out with little promise. After the sub-prime crisis gave birth to the credit crunch in summer 2007, we entered 2008 expecting a quiet year with the possibility of recession in everyone’s minds.

If expectations were low, events proceeded to make even these seem optimistic. After a quiet opening half to the year, all hell broke lose in September as banks toppled and governments panicked. The credit crunch gave way to full-blown recession, with the banking crisis as midwife.

Private equity was left to wander aimlessly amongst the wreckage. Banks, already loathe to part with cash, barricaded their doors. The knocking from the LBO masses went unanswered, and they were left with nothing to do but twiddle their thumbs and wait for sunnier times.

When the financial storm will break is anyone’s guess. Recession is no longer a definite possibility – it’s happening, it’s here. A chorus of private equity voices chime as one note, over and over again, repeating the twin mantras of “we are concentrating on our portfolio companies” and “we see a great many opportunities”. With statistics showing that deal flow is down, no-one seems to be acting on the second.

Next year will be the true test. Private equity has never faced an economic forecast so bleak. In theory, the industry is perfectly placed to benefit – it’s long-term investment strategy will enable it to buy companies, hold on to them for a few years, rejig them a little bit, and then sell on for a tidy profit when the economy starts its upswing.

The problem with this is there are plenty of companies out there which are over-valued. As 2009 progresses, valuations will fall as vendors wake up to the new realities. Bargains can then be had. However, not all will be bargains. Many businesses will be lowly valued because they are rubbish businesses. And not every single one of the world’s buyout managers is going to make the right choices. Some are going to crash and burn.

So the message for 2009 is don’t rush in – as valuations fall, don’t be tempted to put all this equity that’s burning a hole in your pocket to work in any old company that pops up on the radar. Yes there is an opportunity for money to be made, but there’s equally an opportunity for money to be lost. Buyer beware.