Friday Letter: Every cloud has a silver lining

The numbers spell short-term gloom, but private equity is right to trumpet its long-term perspective. The trick will be in judging when the falling knife has hit its floor.  

Sitting here in rain-lashed London, it is hard to put a positive spin on the torrent of negative numbers that marked the year end. Global buyouts fell 62 percent in the second half of what was still a record year, according to data provider Dealogic. In the UK, one of the world’s most mature private equity markets, a similar story prevailed. In the final quarter of the year, the Centre for Management Buy Out Research (CMBOR) calculated the buyout market had fallen by a dramatic 80 percent.

According to Dealogic, secondary buyouts, viewed by most as a sure sign of a booming private equity market, peaked in the second quarter with a record value of $68.5 billion, with the majority of the annual total coming in the first half of the year.

Then the market stalled. In the fourth quarter in the UK, only one secondary buyout of more than £250 million in value made it over the line in the shape of Bridgepoint’s sale of Alliance Medical to Dubai International Capital for £600 million.

In an echo of the wholesale money markets where banks refuse to lend to one another, the buyout firms are no longer counterparties to each other’s deals. Secondaries work best in an environment where multiple expansion is a given and that is no longer the case.

And yet as limited partners are constantly reminded, private equity is a long-term game and a few months pain should be easily endured. Certainly that has to be the philosophy behind the share / unit buybacks proposed by two of the industry’s highest profile quoted entities, The Blackstone Group and American Capital. Both groups believe public investors are over-reacting to the stream of gloomy news.

American Capital, which manages approximately $20 billion, forecast a growth in net asset value last year of 14 percent to 20 percent, equivalent to a share range of $33.50 to $35.42 per share, but in recent days the stock has been trading closer to $31 per share and its yield is near 13 percent. It is planning a $500 million buyback.

Blackstone units have traded as low as at $18, nearly 40 percent off its June issue price of $31 per unit. Citigroup analyst Prashant Bhatia downgraded his target for the stock to $33 per unit from $36, noting that investors are worried about potential tax increases and scarce deal financing, the Chicago Tribune reported.

Blackstone revealed yesterday that its $930 million acquisition of hedge fund GSO Capital Partners would be financed in part by a rights issue, to allow GSO’s founders to be paid in Blackstone equity. Simultaneously it has launched a $500 million buyback programme with the intention to repurchase at least $300 million of units, equal to the units used in the GSO transaction.

GSO’s managers must be satisfied Blackstone’s unit price does not reflect the firm’s fair value. But share buybacks are a dangerous game in a deteriorating economic environment. They may offer a fillip to earnings per share, but if the share price declines markedly they are a dreadful waste of shareholder capital. Here’s hoping the pessimists’ misgivings are misplaced and brighter skies lie ahead.


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