Friday Letter Second lives for the mega funds

A little over a year ago, our sister publication Private Equity International broke from its traditional cover format to run a special ‘black’ edition. The reason was simple: at that point in November 2008, private equity – along with the entire financial services industry and even the wider economy – had been plunged into darkness so complete that no one could predict with any certainty how bad things would become.

However, emblazoned on that atypical cover was a message of hope.  The words “This too shall pass” accompanied an image of a full solar eclipse. The message was this: it was dark then, but eventually things would get better again.

Recent stirrings suggest that things are indeed improving. Dawn may be breaking and private equity professionals can survey the landscape with a little more surety and optimism for 2010.

For one thing, investment activity is undoubtedly coming back. The books closed on 2009 with a flurry of deals, particularly in the mid-market. The trend contributed to the fact that global private equity-backed buyout volumes increased each quarter throughout the year, from $11.8 billion in the first quarter to $36.2 billion in the final, according to a report this week from data provider Dealogic.

Secondaries pricing – a leading indicator of where market participants place private equity valuations – suggests that vital signs are improving for the area of the industry arguably shaken the most by the crisis: the large- and mega- buyout funds.

At certain points last year secondary interests in mega-funds from the ’06 and ’07 vintages were being shopped for as little as 30 cents in the dollar, according to market insiders. Whether this reflected a lack of faith in the assets already in the portfolio, or a belief that any uncalled capital could not be usefully deployed in the reduced-leverage era – or indeed both – it certainly showed that these funds were out of favour.

That was then. But now the market has moved on. One fund investor this week lamented the missed opportunity to acquire more of these funds at what were, in hindsight, bargain prices. He is, he says, now receiving unsolicited offers to purchase the ‘06/’07 mega fund interests he does own at more modestly discounted prices of around 70 cents in the dollar. The market seems to have moved to a belief that many of these funds, while they may not “shoot the lights out”, will not be the “wash-outs” that many feared.

On the whole the large funds have invested in – albeit at high prices with too much leverage – large, solid businesses. There have been casualties and there will be more. Reports this morning that BC Partners, after more than a year of restructuring talks, has lost control of London-based estate agent Foxtons remind us of that. But these instances remain in the minority. 

Meanwhile the darkness continues to recede. There has always been a prediction that those private equity firms that could survive this historic crisis would one day be in a position to again pursue some compelling opportunities. It could be that this day has come already. If it has, limited partners can look forward to a reversal of fortunes too.