Two successive record-breaking years in the buyouts industry should give rise to some satisfaction. But there are problems ahead for which private equity firms have yet to devise coherent, convincing strategies.
An important recent industry conference in New York at least showed there were plenty of ideas flitting about. Dispite the fact that the US market in 2005 saw nearly US$200bn worth of buyouts. The private equity firms and their advisers were far from smug and were able to reflect on the global challenges ahead. The intensity of competition, the pressures on returns and fees, as well as the ubiquitous presence of turnaround experts gleefully predicting doom, should ensure that no-one will take his eye off the ball.
There was indeed a pronounced feeling that things would have to change. As David Wasserman, a partner at Clayton Dubilier & Rice, said: “Deal sourcing is the greatest challenge facing the industry.” Proprietary deals were extremely rare and the impact on returns had been perceptible. He noted that multiples paid in public-to-privates had been especially high, persuading CDR to concentrate on spin-offs.
Private equity has so far come up with two answers to this deal sourcing challenge, but neither has yet been fully explored and neither looks entirely satisfactory.
One is the club deal, consortia of firms that decide to pool resources to enhance their buying power. This appears to be very successful so far, especially as LPs are, as yet, unruffled and as very good terms can be exacted from debt arrangers intimidated by the display of private equity muscle. It allows private equity to target companies that would previously have been seen as too large, such as Hertz in the US and TDC in Europe.
Yet, as some professionals acknowledge, these consortia can be very difficult to put together and could look extremely untidy if a deal sours. None has unravelled so far, but when such a deal does go wrong there could be serious repercussions for this increasingly popular tactic. The club deal could prove to be a fad.
An interesting twist to clubbing is forming partnerships with corporates, something that remains innovative and uncommon. Deals such as the US$3bn acquisition of MGM, which saw Sony join forces with Providence Equity Partners and Texas Pacific Group, at least show what can done.
Since it dilutes the private equity element in the deal, however, this can only be used selectively. Even Blackstone, which has probably completed more deals with corporates than any other buyouts firm, confessed that the radically different viewpoints of financial and strategic buyers would always limit the potential this kind of club deal.
The other answer to the deal-sourcing problem is to explore new geographies and in particular to go east. In China and some other parts of Asia, as pioneering professionals pointed out, there were proprietary deals to be had and almost every auction was a mere formality. Needless to say, Asian legal and political systems present formidable obstacles here. So do rather more elementary problems: for some of the mid-westerners and southerners at the conference, even New York seemed a foreign country.
The likes of Blackstone and Carlyle with their sophisticated global strategies might continue to prosper in the leaner times to come, but don’t bet on everyone.