Friday Letter: Private equity is dead: long live private equity

Many like to call the top of a market, largely because all things cyclical will deliver the forecast decline sooner – or later. At present therefore you’ll find many calling the top of the private equity market.  

But no one can say with any certainty whether the peaks among which many private equity groups currently dwell will lead to a plateau then a gentle slope back down through the clouds or whether there’s something far more precipitous in store.

Doomsayers are predicting the latter and certainly the market for large buyouts is starting to look less benign. There is increased competition for all assets – though managers say it was ever thus. Interest rates are ticking up. Debt packages are starting to look less attractive.

A proposed $18bn buyout of HCA, a US hospital operator, fell apart this week. At the heart of that proposal’s demise was a level of debt that even a consortium of heavyweight private equity firms failed to corral. The probability of the industry finally eclipsing the all-time record buyout of RJR Nabisco now looks much more remote.

Yet behind all the hyperbole and headlines attracted by the mega buyout funds, the private equity market in its broader definition has never been more vibrant.

Fund raising for example, continues to surpass even the optimists’ expectations. Take Gresham, a UK mid-market firm with a solid reputation, who romped to a spectacular final close of its latest £340 million (€494 million; $619 million) fund in a month. Investor appetite for the asset class is still strong.

And then there is venture. 2006 is starting to shape up as the year European venture comes of age. In the last 12 months it has scored a few well-documented home runs. Skype, an internet telephony company sold to online auctioneer eBay, Q-Cells, a solar power business floated by Apax and Betfair, an online gaming site, were essential rites of passage.

The European venture capital industry has known some crashing lows. For the first time since the dot-com boom it can hold its head up high in public and point to real success stories. Tellingly, investors are finally beginning to see some sizeable cheques.

AIM, the alternative segment of the London Stock Exchange, is attracting global interest as a route to exit and a buzz is building around Web 2.0, the next phase of consumer focused, revenue generating sites, particularly after News International, Rupert Murdoch’s media conglomerate, paid almost $600 million for MySpace, a community site.

And perhaps this is the moment venture capitalists would do well not to let a confident step turn to a swagger. One venture manager told PrivateEquityOnline this week he was beginning to find the enthusiasm for community sites disturbing. Not every venture firm could be lucky enough to field a call from Rupert Murdoch or from eBay’s chief executive Meg Whitman, allowing them to cash out on an improbable multiple.

Meanwhile, he said, some of the entrepreneurs were beginning to think of unlikely prices for the VCs to pay. Online T-shirt design sites are the new, new thing for venture investment but firms are struggling to put any money to work in this hot sub-sector, because prices are ramping up.

This is an encouraging development. If discipline remains while the hype builds, then European venture capital should have a profitable future and, who knows, maybe even the profile it deserves. So while some members of the private equity community do descend back through the clouds others will be gladly emerging from below. It’s important to remember that this is an industry that should never only be judged by transactions measured in billions.