Private equity's exit wounds

It's a terrible time for buyout firms to unload their investments, but they'll have to start doing it anyway.

By Grace Wong, staff writer

LONDON ( -- Private equity firms have been battered by the credit crunch on all sides, but the biggest hit of all may come when they attempt to unwind the billions of dollars worth of investments they have made in recent years.

Private equity firms bought companies at a frenetic pace until the recent credit storm ground the flow of deals to a halt. Now they face the unhappy prospect of unloading those investments at a time when the economic outlook is weakening and volatility abounds in the capital markets - and could end up receiving much lower prices than they had originally planned.


Buyout firms are in a real squeeze. Their business models effectively require that they sell - or take public - the companies they buy, usually within three to five years and always at a profit. The abrupt freeze in the M&A market has made that next to impossible to do.

"These are not long-term investments," said Scott Moeller, a visiting professor at Cass Business School in London and former managing director at Deutsche Bank. "When you start looking at this merger wave which began in 2003, you're looking at some companies that when they made an investment were expecting to IPO or sell them starting next year," he said.

The biggest private equity deals have been announced in the last two years, but activity has been steadily growing since 2003. Buyout firms have inked about $2.1 trillion worth of deals worldwide since then, according to deal tracker Dealogic.

But the environment for making so-called "exits" is becoming more challenging. Last month, merger activity in the United States and Europe fell to its lowest level in two years, according to Thomson Financial. Initial public offerings fared better - U.S. deal volume actually rose in August from the year-ago period - but the outlook for next year isn't looking particularly robust.

"It's a terrible exit environment," said Rick Rickertsen, managing partner of Washington-based private equity firm Pine Creek Partners.

In a sign of the tough times, buyout shop Carlyle Group reportedly put the sale of cable company Insight Communications, which it bought in 2005, on hold earlier this month due to a lack of suitors.

Buyout firms can wait out the storm by holding on to their investments for longer periods of time. "Any smart firm has got to be sitting on their good assets right now," Rickertsen said.

But some may be pressured to unload them. Firms that are raising new funds, for example, may need to prove to potential investors that they're able to generate returns in the current market.

Those that do end up selling in the current environment may end up doing so at prices that are much lower than what they anticipated.

"Private equity firms stuck with these investments will have to offer them up at not quite fire-sale prices, but at less attractive prices than they might have expected last year or earlier this year," Moeller said.

At the peak of the buyout boom, private equity firms were willing to buy companies at multiples as high as 10 times cash flow, versus more historical levels of 6 to 7 times cash flow, industry experts said. But the tightening of credit has made it difficult for firms to push valuations higher through the use of leverage alone.

"In general what you'll see is that the opportunity for private equity firms to sell their companies probably won't change dramatically, but pricing will change substantially in the near term," said Monte Brem, chief executive officer of StepStone Group, a La Jolla, Calif.-based consulting firm that advises investors on private equity.

That could end up dampening the recent surge in the buying and selling of portfolio companies among private equity firms. The value of secondary buyout deals has already hit $36.4 billion this year, up 50 percent from the total in 2006, according to Thomson Financial.

The tough market conditions may cause some pain now but is likely to benefit the industry over the long term since a return to more rational pricing will remove some of the froth that cheap money helped fuel, according to Rickertsen.

"Prices are getting reset," he said. "But there is a silver lining for the private equity business overall."  Top of page