The first six months of 2007 will be remembered as the heyday of private equity. The second six months won't. Blockbuster buyouts burst into...
WASHINGTON — The first six months of 2007 will be remembered as the heyday of private equity.
The second six months won’t.
Blockbuster buyouts burst into the news almost daily during the first half of the year, fueled by a seemingly endless supply of cash from the big Wall Street banks. First came the $44 billion purchase of utility TXU by Wall Street giants Kohlberg Kravis Roberts (KKR), Texas Pacific Group (TPG) and Goldman Sachs.
KKR bought First Data in April for $27.7 billion. TPG teamed with Goldman for a $28 billion deal to buy Alltel in May. Carlyle Group, Bain Capital and Clayton, Dubilier & Rice agreed to buy Home Depot’s supply arm for $10.3 billion in June.
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Adding to the heat was an initial public offering by Blackstone Group, a private-equity giant. The good times came to a head around the Fourth of July, just as Blackstone announced its $26 billion purchase of the Hilton Hotels chain. KKR also announced it would sell stock to the public. Private-equity buyouts totaled $64 billion in July.
Then came a tectonic shift that froze the capital markets.
“All of a sudden, this thing happened called the subprime debacle,” said David Rubenstein, co-founder of Carlyle Group, the private-equity giant. “That had a huge effect. Buyout people who were kings of the hill and masters of the universe were suddenly seen as normal people.”
By August, private-equity deals dropped to a monthly total of $8 billion and never rebounded any higher.
Some deals killed
Some deals went through. Some got renegotiated, such as Carlyle’s purchase of HD Supply, which went from $10.3 billion to $8.5 billion. And some deals were killed altogether, such as KKR’s $8 billion deal to buy Harman, the maker of high-fidelity audio products. And J.C. Flowers’ $25 billion offer to buy Sallie Mae, the student lender.
Rubenstein and others said the days of $50 billion deals are over for the foreseeable future, and private-equity firms are retrenching. The bread-and-butter buyout business in which private-equity firms borrowed money to buy companies, then repaired the companies or broke them up for a profit, are unlikely to sustain the 30 percent annual returns that investors have demanded in the past two decades.
“The days of easy money — buying something with a lot of leverage and flipping it in 18 months — are over,” said Frederick Malek, founder of Thayer Capital, a private-equity firm.
Yet analysts see plenty of opportunities for private equity to earn money all over the world and in all kinds of businesses. Carlyle Group, Bain Capital, Blackstone and KKR may soon look more like investment conglomerates Berkshire Hathaway and General Electric rather than private-equity shops.
They also may have a different ownership profile. Giant sovereign-wealth funds, which are government-owned investment firms, have their eyes on U.S. investments, including private-equity firms. Carlyle sold a 7.5 percent stake in its firm to an investment arm of the Abu Dhabi government, part of the United Arab Emirates, in the fall for $1.35 billion.
With cash-rich sovereign-wealth funds investing in, as well as competing with, U.S. private-equity funds, Rubenstein said Carlyle and other buyout firms will need to “focus on many more different types of areas than they did in 2006 and 2007. More creativity will be needed.”
Creativity may simply mean smaller buyouts, in the $2 billion to $3 billion range, with private equity putting up more cash and less debt.
“The next 18 months should be the best in a long time for small, nimble firms that only need to borrow at their historical levels to complete deals,” said Halifax founder David Dupree.
If the U.S. buyout market looks exhausted, the big private-equity firms expect to continue to expand their buyout presence in such places as China, India, Brazil, the Middle East and South Africa, where some economies are growing faster than here.
Look for private equity to increase its presence in other, nontraditional lines of business such as venture capital, real estate and distressed debt.
Private equity may seek to buy some of the $100 billion or so in distressed debt, at a discount, that banks are holding on their balance sheets.
The disruption in the financial markets will make it likely that private equity may begin trolling for investments in devalued banks and lenders, similar to the $30 billion or so in investments that Middle East and Asian governments have made in the past couple of months in ailing financial firms such as Merrill Lynch, Citigroup and Bear Stearns. Carlyle already has a new team exploring that area.
“Some people in the buyout business will look back fondly on 2006 and 2007,” Carlyle’s Rubenstein said. “But we have been investing in good times and bad times for years. The most attractive deals and the highest returns come when there is uncertainty in the market.”