A New Age for Private Equity

Has private equity (PE) seen its glory days come and go?

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From 2005 to 2007, the private equity community enjoyed a golden age of expansion when any deal with a little financial engineering could look like a good deal. PE firms began buying from other PE firms and winning auctions over significant corporate buyers with meaningful synergy. Debt capital was cheap and easily accessible. Indicative terms for senior debt were L + 100 (London Interbank Offered Rate plus 100 basis points) in the heady days, with a total leverage of 7x earnings before interest, taxes, depreciation and amortization (EBITDA) attainable for even an average credit. The various types of creative capital structures offered up by private equity allowed investors to earn just the right return.  It was a good time to be in private equity.

At the onset of 2008, it became clear that the landscape had changed and private equity’s mega-deal momentum had come to an end. Today, most people see private equity firms knee-deep in troubled investments, faced with a dismal future, and can’t help but think the industry is dead. But, private equity is not dead. On the contrary, we believe it’s alive and well.

Certainly, 2009 will present substantial challenges, but embedded within them are some real opportunities to put equity to work. Private equity is no longer a new asset class, but an established asset class that will continue to provide much needed capital for growth opportunities throughout various industries. But first, it must go through a necessary transition period. PE firms will need to revaluate and reinvent themselves—they must be willing to deviate from the traditional private equity model and take on new forms.

We already see the transformation occurring among many private equity firms. Most recently, these firms are allowing for greater flexibility in the way the deals are being structured. They have gotten over their need to have control positions in every deal, and are more willing to take a minority position. They now will consider teaming with strategics to provide capital to help facilitate acquisitions. These types of modifications and creativity will give private equity the momentum to prosper again and provide value in the transaction marketplace.

Once it emerges from this reengineering of itself, private equity will continue to be tasked with the goal of deploying a significant amount of capital stockpiles left from the golden age. But by changing gears and putting the focus on growth equity, minority equity stakes, recapitalizations, and yes, buyouts, private equity will continue to play a key role in the lifecycle of certain businesses and within certain industries.

Historically, the automation sector has shown greater resiliency in a down market, and this could position well-managed companies for considerable opportunity. “The focus is shifting from how well companies handle a downturn to which companies will benefit early in the cycle of the upturn,” says John Mavredakis, Head of Houlihan Lokey’s Financial Sponsors Coverage Group. “There is great buying opportunity, and we expect 2009 and 2010 investments to have fantastic returns. When you buy low, high returns generally follow.”

Heightened regulation

The private equity community will also likely be faced with enhanced regulation; however, this is something that everyone is prepared for. “There will be heightened regulation and the industry will have to deal with it. It’s just a sign of the times,” says Mavredakis.

Private equity, it seems, has not let the glory days pass it by. In fact, despite its recent bad rap, PE could play a significant role in the market’s rebound. It may be a long time before we see the likes of those infamous megadeals again, but hundreds of billions of dollars of committed capital still lie in the hands of investors, and unless the credit markets loosen up, these funds will be much needed.

Jim Lavelle, JLavelle@HL.com, is Managing Director of the Industrial Technologies practice, and Eugene Bazemore, EBazemore@HL.com, is Senior Vice President of the Industrial Technologies practice of Houlihan Lokey.

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