Friday Letter 12 unusual months

PEO takes a look at some the year's top challenges to the industry, as well as some encouraging indicators.  

As PEO noted a week ago, 2009 could be called the year of the adjective. Weird, challenging, interesting, humbling, Darwinian, revolutionary, chastening and thrilling are among the terms that have been used by industry insiders to describe the past 12 months.

That being said, the language employed to describe the outlook for private equity became more positive as 2009 progressed and the mood got better. And if you review the major stories of the year now that it is nearly over, the trend towards greater optimism becomes apparent, too. Here’s our pick of the themes that dominated the agenda of the past 12 months. Some speak to the grimness of the state we’re still in; others, especially those that have emerged in recent months, bode well for what’s to come next year and beyond: 


1. Placement upheaval. Citi, Merrill Lynch and Deloitte were among the instutional fundraisers that decided to wind down activities or saw their teams spin out. Such decisions were fuelled by a global slowdown in fundraising coupled with likely US regulations on the horizon against the use of placement agents, stemming from the grim pay-to-play scandal initially uncovered in New York. Now the boutique agents that can withstand the turmoil are expected to thrive.

2. Regulation rollercoaster. The European Union continued to refine its controversial Directive on Alternative Investment Fund Managers, which is expected to cost billions in compliance costs, impact manager compensation and limit LP access to certian funds. Across the Atlantic, numerous pieces of legislation were proposed by US Congress members, including bills that would require SEC registration, give states power to regulate managers and increase tax on carried interest.

3. Portfolio management mania. The financial crisis and the global recession caused headaches for all GPs. “Everyone has a few problem children in their portfolio”, was a phrase PEO heard uttered throughout the year. In some cases, that meant renegotiating convenants or raising and injecting fresh equity to maintain and enhance value, while in others it meant handing the keys over to banks and distressed debt firms.

4. Limited partners unite. The Instituitonal Limited Partners Association – whose members are among the most influential private equity investors, controlling some $1 trillion in assets – released a set of LP-friendly guidelines on issues including carry distribution, deal fees, key-man clauses and corporate governance. Meant to be a best practices talking point for GP-LP negotiations, the guidelines were unveiled at a time when LPs worldwide have significant negotiating leverage on partnership terms and conditions.

5. General partners acquiesce. Many GPs took voluntary good will steps to appease or assist LPs with liqiudity issues and overexposure to the asset class. Large-cap private equity firms including Permira, Terra Firma and TPG returned millions in fees and/or carry because their dealmaking pace slowed, while firms including TPG, Permira, Apax and Sun allowed LPs to reduce commitments previously closed funds.

6. Fundraising plods on. The previous point notwithstanding, it’s also the case that not every limited partner is currently out of pocket. Fund targets have become more modest and roadshows may take longer. But the oversubscribed offering is by no means a thing of the past, and here in PEO's newsroom, our inboxes have been increasingly filled with news of successful closes – particularly for secondaries and special situations funds. In just the last few days we've seen closes by firms including Partners Group, Marlin Equity Partners, F&C, Altamar and Kelso Place.

7. Private equity to the rescue. Aside from the many struggling companies provided cushion by private equity investments (like JLL Partners' and Warburg Pincus' recap of Builders FirstSource), the troubled FIG sector also had PE lifelines thrown to it. The most notable example was BankUnited – Florida’s largest independent bank and the largest US bank to fail this year – which was saved by a syndicate including Blackstone, Carlyle, Centerbridge and WL Ross.

8. Revolution and evolution. While the restructuring of teams and funds (Alchemy, PAI, Candover) captured attention, so too did changes at firms that can no longer be described as “just an LBO shop”. KKR is perhaps the best example of this, having added infrastructure, fixed income, mezzanine, real estate and public equities platforms, as well as a capital markets advisory business. The integrations of these units, KKR’s founders have said, is seen as crucial to the success of an investment firm faced with a changing landscape. The broader point is the need for all firms to evolve – and will not be lost on anyone.

9. Exits make a comeback. Portfolio companies big and small have been lining up to exit via IPO or trade sale (or both, as the dual track sale approach remains common). Thomas H Lee, Quadrangle, Enterprise Investors, BC Partners, Doughty Hanson, Duke Street, Blackstone, 3i, Carlyle and Warburg Pincus were among the many firms able to give this welcome news to investors.

10. Momentum builds. While traditional financing sources “still remain cautious in the LBO debt arena”, as one banking source put it, and it may take more lenders to get things done, fresh deals (even secondary buyouts and auctions) are back on the table. Just in the last two weeks, large, leveraged deals have been done by firms including Apollo, Apax and Blackstone.

If the momentum carries on, 2010 could  deliver a turning point for private equity. As the decade draws to a close, rumours of the industry’s demise seem to have been exaggerated. The road ahead will not be straightforward, and if this year was “unusual”, then next year will be, too. But smart and hard-working managers will continue to find ways to solve problems; therein lies the key to long-term prosperity and survival.