A new report from a private equity research bank says that over 800 funds will come to market this year for a combined target of US$250bn. The figure sounds high, but the estimate is worldwide and across all fund categories. The same reports predicts, however, that only 350 of these funds will achieve a successful final close, albeit for the impressive sum of US$200bn.
That suggests that a staggering 450 of the funds in the market this year are going to fail. It is a proportion that takes on even greater significance when you consider how demand for private equity has grown in the last 12 months. According to the same report, demand could outstrip supply by as much as US$160bn because many LPs are below their target allocations to private equity, and portfolios have been experiencing net inflows since late in 2003.
If this scenario plays out, it points to growing sophistication and selectivity on the part of LPs, as exemplified by increasing emphasis on the due diligence process. Differentiation is of course the key in this environment, and means sorting out the GPs that really do have access to proprietary deal flow, as well as the ability to deliver compelling returns.
The other, and perhaps more pressing question is where will all that funding be invested? Vendors like the owners of Spanish telecom firm Auna, are playing the stock market and private equity against each other, and it is not as if there are a multitude of alternative targets.
As things stand, private equity is not willing to meet the ambitions of the Auna shareholders. If the stock market revival proves fickle, then perhaps there will ultimately be a bargain. But if the equity market holds up, and many signs suggest it will, Auna, Wind and a whole series of other assets could bypass the buyouts market altogether.
Then there are the trade buyers, poised for a return to the markets this year. Deutsche Telecom may partner with Blackstone in pursuit of Wind, but France Telecom is looking to acquire the business on its own. Whether European telecoms should be embarking on another round
of M&A so soon after the problems that blighted the sector is another matter. And we should not forget the hedge funds, increasingly looking to take positions in private equity funds, but also moving towards a scenario where they will be better able to compete for assets directly. They don’t know as much about turnaround as private equity firms, but they can always recruit the talent they need – that’s what they did with all the debt traders.
The other caveat for hedge fund involvement in the industry is the short-term nature of the hedge fund business itself.
Watch out for new legislation in the US that will allow hedge funds to call themselves private equity funds if they have a minimum two-year lock up.
Are we all alternative asset managers now?