In the past 12 months we have seen credit markets come back faster than expected. Federal Reserve policy has kept interest rates near zero while improving fundamentals and a return of confidence have ultimately led to tightening spreads.
This dynamic had two effects:
1.) Sponsor-backed companies were able to aggressively amend capital structures and extend debt maturities, presenting extended runway for vintage deals from 2005-2007.
2.) Overall depth of the credit markets returned, fostering multi-billion dollar buyouts sooner than most thought possible. Unfortunately, the IPO market did not cooperate in 2010 as buyside investors largely stayed away from deleveraging stories and the IPO window remained shut for leveraged companies for most of the second half of 2010.
Projecting ahead, GPs will attempt to drive more exits and return of capital to LPs. In contrast to last year, expect to see the completion of large sponsor-backed IPOs in 2011 as solid fundamental performance will replace deleveraging stories.
As a result of higher PE marks, successful return of capital by GPs and rising equity portfolios for LPs, top quartile managers will have reasonable success raising follow-on funds. In terms of new deal activity, franchise businesses, high growth companies and corporate divestitures will continue to attract heavy sponsor activity. However, the bar will, and should be, raised on the standard of new buyouts given current valuation and leverage levels. Note that the S&P 500 has increased over 75 percent since reaching bottom in early 2009 with positive fundamentals in 2011 already priced in for many companies.
Similar to 2010, emerging markets will remain a major focus as firms become a bit more flexible around the degree of control they require. Additionally, top firms with true sector specialisation and real operating resources will continue to drive performance alpha in the coming year. And we will likely see early signs that 2009 and early 2010 deals will prove to be an incredible vintage for returns.
2011 will be an exciting and challenging year as GPs wrestle with positive fundamental performance offset by higher valuations, cash rich corporate buyers and an increasingly uncertain interest rate environment.
Greg Mondre is a managing director with Silver Lake.