Friday Letter: Mad dance

The LBO party is still going strong – though some participants must be hoping for the music to stop.  

At a lunch earlier this week, Citi’s private equity investment team expressed an enthusiasm for investing in private equity untrammelled by concerns that the market might be overheating.

They highlighted the fundamental, structural opportunity that still exists globally for managers to turn to institutional private capital to fund the next stage of their companies’ growth. They played down worries about over-leveraged businesses with covenant-lite structures. Nor did they seem unduly concerned by the serried ranks of legislators, regulators and unionists all looking to curtail the buyout industry’s perceived excessive success.

It was, relatively speaking, business as usual in a cyclical game that is reaching a peak, although who knows when exactly. As one of the Citi execs noted, it is rarely wise to try and time the market. You should instead concentrate on how hard you are hitting the accelerator – or gas pedal, as he said.

The team was certainly on message with Citi’s chief executive Chuck Prince. According to a report in the Financial Times, his bank is “still dancing” on the back of the buyout boom which will continue to be fuelled by deeper “pools of liquidity” than in the past.

Prince argued the liquidity in the market meant private equity would not be stopped by difficulties in the US subprime mortgage sector, although he conceded the good times would eventually end. He said: “When the music stops in terms of liquidity things will be complicated. But as long as the music is playing you’ve got to get up and dance. We’re still dancing.”

Prince may have good reason to be bullish. The group’s banking arm has received $618 million (€454 million) in fees from buyout firms in the first six months of the year, according to data provider Dealogic’s first half results.

However, in choosing the dancing metaphor, he sounded a bit like a marionette from a Brothers Grimm fairytale, struggling to control his limbs and unable to resist the sorcerer’s enchanted tune.

Of course the banks will continue to lend while defaults are low, fees are high and investors are buying. Managers will continue to raise ever larger funds to satisfy investor appetite for alternative assets. And as funds grow, so too the pressure to invest increases, especially while interest rates are still at historic lows. It is all entirely rational behaviour in isolation. But taken together and the dance is reaching a fevered frenzy – and those with the luxury of stepping aside are celebrating it.

Earlier this week, Paul Achleitner, German insurer Allianz’ chief financial officer, confirmed his business’ commitment to absolute return investments such as private equity. Indeed Allianz turned out to be Jonny Maxwell’s new home, with a mandate to grow its private equity fund investment portfolio.

But Achleitner declined to forecast specifically how much capital it might invest in the asset class going forward. Speaking to journalists at a roundtable in Frankfurt, investing from the balance sheet means if Allianz does not like the band’s tune, it can sit out the next dance. Freedom from the pressure to invest is a huge asset, he said.

Nevertheless, the bankers, the GPs and their advisors all believe you’d be mad to turn away quite yet. And that kind of makes sense too.