The summer of discontent

So has it finally happened – the downturn that has long been predicted? It certainly looks that way – the large buyout market will effectively be closed for the rest of the year.

The past week has seen a number of deals flexed upwards with additional fees (see below), other deals such as Cadbury’s auction of its US beverage division have been delayed, and there are question marks surrounding the Saga/AA merger.

The death of “cov-lite” deals is a now a certainty and private equity houses can also kiss goodbye to any significant refinancings in the short to medium-term, which will create bloated exit pipelines with little chance of decent IPO activity.

But is this the beginning of a bear market? The answer is “no”.

First, there are plenty of reasons to believe that last week’s blow out is just an overdue correction in what is still a bull market. Massive refinancings, huge senior tranches and cov-lite deals were signs of an overly frothy market and a correction now before it’s too late can only be a good thing.

Second, the LBO credit crunch is more a function of investor perception. The sub-prime mortgage debacle in the US is making them more risk-conscious. That’s got to be healthy in the long run. Financial regulators and central banks were growing increasingly concerned over investors’ blatant disregard for risk.

Also, it is not as if there are lots of defaults on these deals. Debts are being serviced.

Another factor is that the FTSE 100 is trading on a P/E ratio of 12, compared with its historical average of 14 and 26 before the dotcom crash. Therefore, companies don’t look overly pricey. Balance sheets are relatively robust and profits at the larger companies have on average been above expectations.

Then there’s the economy. On both sides of the Atlantic it is growing at a steady pace – not spectacular – but hardly recessionary either. And the global economy is doing even better. All of this suggests that the fundamentals are basically OK. That means companies should be able to carry on growing and generating profits.

Once the current lot of deals get syndicated and the markets settle down, takeovers will once again bloom. Hopefully, with investors making more realistic assumptions about risk, leverage won’t be too high and the terms not too demanding.

If that avoids problems with servicing debt later in the economic cycle, then that can only be a good thing.

Blackstone goes private
Wall Street dealers managed some black humour as the markets crashed last week. One suggestion doing the rounds was that Blackstone might want to take itself private. Its stock has fallen by 20% from its June IPO level and by more than 30% from the high seen straight after its flotation, to make it the worst performing significant IPO of the year. Blackstone meets other standard LBO criteria as well as an underperforming stock price. It is hugely cash-generative and has not benefited from public market scrutiny, for example. Disclosure of chairman Steve Schwartzman’s enormous compensation and minimal tax payments marked a public relations disaster for the private equity industry. And the sudden freeze in the LBO market could leave Blackstone principals underemployed in the coming months. So why not buy yourself out?