Outlook 2012: Chipping away the overhang

Firms should bite the bullet and realise investments next year, despite the disconnect between pricing expectations, writes Alex White, a corporate finance partner at BDO.

2011 was another year of frustration for private equity, but 2012 may bring about a sea-change. Funds are ageing and there are still not enough deal opportunities to deploy the funds raised pre-Lehman.

Investments are ageing too and investors want cash back before they can start allocating capital to new funds.  We are now entering into a private equity crunch phase where lack of realisations in the sector will hamper future fundraising efforts.

Private equity is holding on to its assets for too long and there is a conflict between what GPs and LPs want. GPs who have held back from selling assets may not be doing what their LPs want and what the industry needs – that is to recycle funds and quickly.

There has never been so much organised risk capital available to companies at this point in the cycle and it is propping up valuations. Vendors still think pricing is low and buyers feel it is too high. That’s life.

But what is important here is that there remains a massive overhang of private equity (estimated at over €120 billion in Europe) which must be invested in a market with a relative lack of good deal opportunities.  With demand for investments outstripping supply this is resulting in a scarcity premium being paid for the best businesses.  In turn this is having the effect of a general propping up of valuations.

But it will not last. The private equity overhang will disappear by 2014 and will not have been replaced because LPs are committing less capital to new funds. When that overhang goes valuations could go down as the demand for deals comes out of the market. Anyone thinking about selling should get on with it.