Thomas Lee,
President and CEO, Thomas H. Lee Capital LLC
David Solomon,
Managing Director, Goldman, Sachs & Co.
Moderator:
Maria Bartiromo, Anchor, CNBC's "Closing Bell with Maria Bartiromo"; Host and Managing Editor, "Wall Street Journal Report with Maria Bartiromo"
CNBC's Maria Bartiromo (seen here with David Jackson) moderated this panel analyzing the immediate prospects for private equity.
Last year, the Global Conference held a panel called "The Year of Private Equity." Just 12 months ago, mega-deals were being announced on an almost weekly basis, credit was ample and cheap, and private-equity firm managers had the allure of medieval kings. But what a difference a year makes. The IPO of private-equity blue chip Blackstone was disappointing, the credit crunch has taken a toll on the private equity market and investors are uncertain. Against this backdrop, moderator Maria Bartiromo of CNBC launched the discussion by culling the panelists' opinions on where the industry stands.
Leon Black of Apollo Advisors was quick to quip: "I'd have preferred if the title had been 'before the year of private equity' because that would imply a hope that things will be better next year." To be sure, there was a quantum jump leading up to 2006 driven by several factors: Sarbanes-Oxley motivated firms to go private, CEOs did not want to stay public with their compensation packages, and the aggressive credit market lead to bigger and bigger buyouts. Now the first two of these effects still hold, but the credit market is broken. Black emphasized that that this is not the first time such a crunch has happened. When Apollo started operations, it was a pretty similar environment. According to Black, there will always be good opportunities for private equity. Right now there are moves to be made, particularly in the distressed buyout market. There are also regular private equity opportunities depending on when banks go back to business.
David Jackson of Istithmar World Capital remarked that "2006 and 2007 were bizarro world." He did not think that credit markets are broken and felt that deals that make sense are still going through. The only issue is that "jumbo" deals are not happening. He also drew attention to the globalization of the leveraged buyout business. "There's life outside the U.S.," he noted, mentioned the rising importance of Asia, the Middle East and Turkey.
According to Thomas Lee of Thomas H. Lee Capital, the downturn in the private equity business was by and large a securitization issue. From 2001 to early 2007, the share of CLOs grew from 10 percent to 70 percent of total loans, which in effect created $10 trillion of liquidity that was in turn pumped into areas like private equity, boosting deal volumes. These days, banks are busy clearing the credit backlog instead of offering new liquidity. He also noted that in terms of availability of financing, there was no longer much difference between investment banks and commercial banks. There might be some re-regulation in the direction of Glass-Steagall. Elaborating on the extent of current deals in the market, Lee remarked: "What I'm doing now is mid-cap deals, and I call that back to the future." In fact, that's what the industry used to do in the regular past.
Jackson seconded Lee, stating that mid-cap is really the typical private equity deal. He referred to data indicating that average deal sizes have fluctuated around $100 million over the last decade. Most notably, even in the boom year of 2006, deals averaged $240 million. These days, the nature of some of the relationships in the industry has changed; now the PE shops are trying to sell the banks the deals, instead of the other way around.
David Solomon of Goldman Sachs noted that capital has started to form in order to take over bad assets, and he gave as an example some very recent deals happening with large commercial banks. With this capital recycling process, assets can now be better marked to market. He also made a distinction between access to capital and the state of the economy, and argued that going forward, the bigger issue will be how consumers behave.
Another interesting topic revolved around high returns usually associated with private equity. What should investors expect in the current environment and in the near future?
Leon Black conceded that closing deals of the conventional type will be more difficult, but then again, "there are many roads to Rome." For instance, Apollo has invested $4 billion since last October, and some of these don't require any leverage at all. Black noted that the distressed buyout market provides many opportunities, which is actually a de-levering process that has happened many times before, as in the early 1980s and near the end of the 1990s. Not surprisingly, some distressed-private-equity funds had their best performance in times like this. He argued that for better private equity returns, equity prices needed to come down and we might have to wait six to eight months for that.
Thomas Lee referred to a chart displaying annual average private equity returns. While such returns were around 20 percent during most of the 1990s, they dropped to zero later on and came back to the 20 percent level in the mid-2000s before nose-diving to the negative area last year.
Black also elaborated about the Blackstone event. He argued that Schwarzman had built an excellent firm and what went wrong was that people had just invested in the IPO at the top of the cycle. According to Black, the market is still confused about what private equity does, putting too much value in quarterly reports. Over time, distinctions will be made between short-term issues and the long-term performance that private equity can deliver. Most limited partners in PE funds come in for a period of 10 years, in stark contrast with quarterly earnings expectations in public markets.
In closing, Bartiromo asked panelists about what opportunities to chase and what to avoid in private equity. The panelists had pretty convergent opinions on this topic. One common thread was increasing geographical spread, with special emphasis on Brazil, Asia and Eastern Europe. According to Solomon, "The world just feels better as you get away from Manhattan." Jones enthusiastically remarked that Brazil has become a net creditor country for the first time.
The globalization of PE is driven not only by availability of local funding, such as from sovereign wealth funds, but also by the increased sophistication of local institutions which have succeeded in adopting the financial toolkit to their circumstances. "U.S. institutional involvement is no longer required for deals," noted Jackson.
According to Leon Black, the crucial issue is how good the investee company is. The math of deals is not complicated, but finding a good company is. At a market-wide level, Black's view was memorable: "Volatility is not one's enemy as an investor." The remaining panelist sounded along the same lines with Black: they do not specify a particular sector or geographic region. The opportunity always depends on the specific investee company, and sectorwide considerations are typically limited to the timing of the investment.
Global Conference 2013
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