Transformation or regression?

The World Economic Forum in Davos last week gave us an interesting insight into where the private equity industry feels it is at in these rocky times.

David Rubenstein, a founding partner of Carlyle Group, kicked off the debate on a happy note for the industry, saying that criticism of private equity has been re-directed at sovereign wealth funds. He even went as far as to say that people were almost sympathetic towards private equity in the light of the current debt shortage.

But he argued: “You don’t need to shed tears for private equity firms. We have transformed ourselves over the last three or four years to firms who are not dependent on leverage to do large buyouts – most large private equity firms are now multi-product organisations doing non-leveraged transactions including minority stake deals, real estate and venture capital, and we have also diversified out of core countries. Most large buyout firms are investing in emerging markets, which don’t need leverage; there will be much more money poured into these countries over next few years.

“There is a transformation going on in private equity and it is a healthy transformation”, he continued, “we will continue to diversify from things done in the past while retaining the expertise to do big deals when they come back.”

He said the main focus going forward was on improving portfolio companies, “not doing new deals but fixing and improving companies we already have – it is here we can show our expertise”.

Donald Gogel, president and CEO of Clayton Dubilier & Rice, added: “Remember we are able to be selective; CDR went through three full years in the 1990s when we made no new investments. The private equity industry does not have cash on hand but forward commitments from loyal institutional partners, who are just as happy when the market is not good for investments to let us sit and wait until the right time.”

Now there is, of course, truth in all of this and, indeed, many of the larger firms have diversified themselves into multi-product organisations that will provide other revenue sources as the big transactions dry up. But this is clearly an industry on the defensive.

The main point is that unprecedented fundraising has taken place over the last two years. These funds have not been raised to increase investment in venture capital. This money was committed with the view to large transactions coupled with massive returns, not comparable to those from equity only transactions.

If these private equity firms are not able to make sufficient investments to drawn down the raised capital, this will of course effect fundraising going forward – however enlightened the “loyal institutional partners” may be, if money is not used, effectively “returned” to investors, then the industry has taken many an almighty step backwards.

And surely, to spend the time “fixing” companies they already have in their portfolios does raise the question of what they would have done in booming debt times, when investment professionals were busy making investments and not concentrating on portfolio management.

However, there must have been an almighty smile on the face of many industry critics when Joseph Rice, the co-founder of Clayton, Dubilier & Rice, reportedly announced at the forum: “If the market continues to be choppy, we might have to do what investment banks have done,” alluding to lay-offs.