Is Private Equity the Next F!cked Company?

 

Just how bad are things going to get for Australian private equity?  Internationally, the Financial Times warns that December quarter private equity valuations will be marked down by more than 30%.  This strikes me as a best case scenario.  After all, listed equity markets are down by over 40% and private equity investments are typically leveraged at two or more times the levels of their listed peers.  And let's not forget private equity's disproportionate exposure to hard hit consumer sectors, including retail.

So, are the private equity guys going to get savaged?  Is the industry buggered?  The Boston Consulting Group are smart people and they certainly think so.  BCG is predicting a massive industry shakeout, a perfect storm, culminating in 40% of LBO firms going out of business.

I had planned to write a post explaining why I believed Australian private equity would escape most of this carnage.  But then I decided to take a bottom up look at the 45 or so firms that I consider the core of our local industry.  I removed the international players like KKR or NAVIS, which left me with a focused list of about 40 locals. 

I then did a back of the envelope assessment of their prospects for survival assuming that the fund raising environment remains very challenging for at least three more years. My analysis wouldn't win an award for rigour, but I know most of the firms pretty well and I also looked at websites, past editions of the AVCJ, and other obvious sources.  It was surprisingly easy to assign the managers into "survivability bands" based on their deal track records, current portfolio prospects, team continuity, and capital reserves (obviously a firm like PEP, who just raised $4 billion, can sleep easy).

I was surprised by the result.  Very surprised.  I could only confidently say that just over 20 of the firms, call it 60%, had a clearly sustainable business and would survive through the cycle.  Maybe the powerpoint jockeys at BCG aren't being excessively gloomy after all.

Last thought on this:  private equity is a notoriously "inefficient" industry.  The ten year structure of funds and the passive nature of most limited partners encourages poorly performing GPs to remain in business longer than they should, to hang on for years after it becomes obvious that they have failed to deliver good returns. 

My point?  A handful of Australian firms will disappear quickly-- perhaps even during 2009.  They will merge with peers, key men will resign as hopes of carry evaporate, and we may even see limited partners become more active and vote out a GP.  But the majority of private equity managers caught in BCG's "perfect storm" will simply become living dead firms.  They will very slowly withter away over the next decade . . . cheerful stuff, huh?

Comments

[RJB]

Great post. I definitely saw this "living dead" thing happen in the VC world after the dot com crash.

Eight years later there are still VC firms in the States milking the old management fee on dud tech funds. They will never raise another but it pays the rent!!

[Frank Lorenzo]

The same is so true in Oz. I work in a tech startup and since 2003 have got a pretty good feel for the venture thieves. There are Aussie VC firms which everyone calls leaders or the best but IMHO will never raise another big vc fund. Allen and Buckrige, TVP, Momentum for example. Also a lot of the gov backed funds like preseed and I.I.F (spelling?) were disasters and the vc are now just milking our tax $ for the rest of their fees.

I might be totally wrong, but I would be surprised if firms like TVP or A&B will raise $ ever again. Good vcs raise money every few years. They have not raised for eight or ten years. So you have to wunder.