Friday Letter: Party Bore

PEO is disappointed to be feeling curmudgeonly this week.  

The team has been talking to enough bankers and GPs to be left with little doubt that the party has been a big one – the trail of discarded glasses and random items of clothing testify to that – but perhaps like anyone not in the heat of the action, the prevailing impression has been one of concern (and certainly for others, disdain) at the over indulgence.

Because the great leveraged finance party is going to take a lot of clearing up.

Various clues catch the eye. Such as: according to Standard & Poor’s LCD data unit, in July the average rolling-three month European LBO purchase price multiple to EBITDA soared to 8.5x, compared to an already intoxicating 7.8x peak reached in the boom of 1998 – and up from 7.4x in April of this year.

Or listen to Jon Moulton (admittedly a noted curmudgeon) of Alchemy Partners declare: “We have only done one new deal in the last 12 months, compared to about eight normally, because we think you won’t be able to sell at today’s prices in a few years time.”

And if you are feeling especially downbeat, tune in to the many and varied voices in the mainstream media carping at the faceless, heartless, graceless nature of private equity ownership. At present this rising tide of negative sentiment is being fed by the trials and tribulations at the UK arm of Gate Gourmet, the airline food services company owned by Texas Pacific Group (TPG). Many column inches have been dedicated to the seeming intransigence of existing management and the alleged connivance of past management to provoke unofficial industrial action. And others have expended their keystrokes on how much The Rolling Stones were paid to perform at TPG founder David Bonderman’s birthday party.

Besides the merely sensational and the alleged, there is a broader message in this coverage, one that will only get more strident – and more difficult to counter – when (and even amongst bankers, it is when, not if) more large LBOs founder. Some will focus on the unemployment that ensues from the restructurings and bankruptcies that take place. Others will question the merit of applying large amounts of leverage to companies (cue words like “crippling”, “saddled” and “paralysing”). And others will stand back and ask: who wants to put money into private equity when its idea of transformational investing is to blow companies up?

One more thing. Readers may have noticed the story on PEO this week about the research study undertaken by two US academics, which revealed that buyout and VC returns have on average failed to match those of the S&P500. This does less to weaken the asset class’ superior performance proposition than might first appear – although it does reaffirm the fundamental importance of manager selection.

But the academics also made the point that new partnerships are more likely to be started in periods after the industry has performed relatively strongly (as in today’s market). Yet, those vehicles raised in so-called “boom” times are less likely to raise subsequent funds – the authors suggesting that this is due to poor performance and further suggest that during these periods of optimism, a larger percentage of capital flows to the lower-performing funds than to the top ones.

Which suggests that the current fundraising boom is going to include a legacy of moribund funds populated with dead or dying companies and a startlingly broad cross-section of people – LPs, bankers, employees, journalists – all wanting to know (in several cases, somewhat disingenuously) how the party got so out of hand.