Private equity: from here to where?

Decreasing interest rates and loosening lending standards fuelled the private equity sectorís growth in recent years. Global economic downturn however, has thrust its future into uncertainty. Are we seeing the passing of the ëgolden eraí? It would certainly seem so.

Until 2007, banks were keen to lend into leveraged buyouts. 2007 Saw Europeís largest ever buyout of Alliance Boots by US Kohlberg Kravis Roberts (KKR) for $14 billion. However, the boisterous buyout confidence of past years has all but dried up. US private equity fundraising raised just $15.3 billion in the fourth quarter of 2008 representing a 75% drop from the last quarter of 2007. Jennifer Rossa, managing editor of Dow Jones Private Equity Analyst said declines in current portfolios are causing investors to ìwait-and-see before committing more capital to the asset class.î

As the financial crisis grips the industry, to where will it turn? Cheap debt is no more and investors now look towards the quality of their returns much more intensely. The truth is, the financial crisis could see the private equity industry reinvent itself with a brand new business model from a growing popularity of certain asset classes.
Infrastructure funds are earmarked for increased growth in 2009 due to their significant role in bridging the funding gap in government budgets and their inclusion in stimulus and job-growth plans under the Obama Administration. Case in point, the largest highway privatisation in US history appears imminent with a $12.8 billion bid to lease and operate the Pennsylvania Turnpike.

Washington, D.C. Institutional Investors believe emerging markets (EM) will present attractive investment opportunities in the coming year while Western markets dwindle. The Emerging Markets Private Equity Association reports that four out of five existing investors expect to expand their exposure to EM Private Equity in the next five years with China the most attractive destination amongst Limited Partners. Infrastructure expenditure in EMís is projected to grow 80% over the next three years with $2.2 trillion spent annually. Governments alone are unlikely to supply this amount leaving private equity to fill the gap.
KKR has hired former US ambassador to Saudi Arabia Ford Fraker as part of a drive to build business in the Middle East following its recently set up subsidiary in Dubai. Ford Fraker commented that ìthere are ample investment opportunities - throughout the regionî. Giants such as KKR are expecting a flood of merger and acquisition activity in the Middle East. An attractive opportunity for a firm set to raise $542 million to prop up struggling European investments.

Now, we see private equity firms stepping into the banking industry. A rescue plan to be celebrated or an immoral shift in control born from desperation? The US Office of Thrift Supervision recently approved the buyout of Flagstar Bancorp, a struggling bank in Troy, Michigan by MaitlinPatterson Global Advisors. The Federal Reserve (FR) which oversees national banks prohibits a private equity company from buying a majority stake in a bank so as not to pass control. Is this wise when private equity firms are sitting on $1 trillion in cash while banks are desperate for capital? Carlyle, W.L. Ross, Blackstone and Centerbridge all expressed interest in Floridaís BankUnited. Unsurprisingly, there have been calls to relax the regulation.

We may be seeing the passing of a ëgolden eraí however, we are dawning on a new era where private equity firms adopt a more savvy approach to the type of asset class they acquire and their geographic position in the global market. If global firms develop deep-rooted relationships in EMís to compete with local firms and governance retracts in the banking industry, we should see no reason why private equity wonít excel once again.