Inflated expectations

There is a vast amount of private equity money out there looking to be invested. As explored on p.16, an estimated $490 billion of committed capital is awaiting deployment around the globe. To investors, it is comforting to know that as golden investment opportunities emerge from the ongoing economic malaise – as history tells us they will – some firms have the reserves to seize them. Nevertheless, a recent spate of heated auction processes in Europe – which 12 months ago would have seemed outlandish – suggests that all that committed capital is finding only a very limited number of quality assets to bid on.

Kohlberg Kravis Roberts’ acquisition of Pets at Home from Bridgepoint at the end of January is a case in point. An auction process culminated with the pet shop chain being sold for £955 million (€1.1 billion; $1.5 billion). A source close to the process said the KKR bid represented an 11.3 multiple based on Pets at Home’s 2010 EBIDTA projection of £84 million. If calculated based on Pets at Home’s most recent annual EBIDTA figure, totalling around £70 million, the sale was agreed at a 13.6 EBIDTA multiple. “That’s a high multiple for retail by any measure,” said the source.

Toby Mitchenall

Survitec, Marken, Spotless Group, LGC Group: all these European businesses have recently changed hands between financial sponsors in competitive sale processes. A noticeable increase in the number of secondary buyouts has lent weight to the argument that private equity capital, having waited on the sidelines for much of 2009, can wait no longer. The clock is ticking on funds’ investment periods, and money needs to get into the ground. The overhang is ensuring the limited number of assets that have proved strong enough to weather the downturn are in high demand. They will not be acquired on the cheap.

The secondaries market, meanwhile, has an overhang of its own. Data from secondaries broker, placement agent and advisory firm Probitas Partners indicates that a massive $22.3 billion was raised worldwide in 2009 by secondary fund specialists. Secondaries fundraising totals increased 201 percent between 2008 and 2009, boosted by fund closings from the likes of LGT Capital Partners, Partners Group, HarbourVest Partners and Goldman Sachs.

Now these funds need to be invested, too. No official data is available for the volume of secondaries deals closed last year, but estimates vary between $6 billion and $10.5 billion for what had been hailed by many as “The Year of the Secondary”.

“Some people have over-paid and are still over-paying for assets,” says one partner at a large European secondaries investor. “There was a lot of capital chasing deals in ‘09 that weren’t really there,” says another. Could such reports be taken as the first signs of a bubble in the secondaries market?

Managers of secondaries funds – in particular those currently raising money – give a number of reasons why the overhang that is pushing their competitors to over-pay for assets does not apply to them. “I do not worry about the statistics, because at our level of transaction we always find value,” is the answer one manager gave me when I asked if he was concerned by the volume of unspent secondaries capital. Other reasons offered tend to focus on the various niche skills managers lay claim to: the ability to do small deals; the ability to do large deals; the ability to do very complicated deals.

Managers of secondaries capital would argue that “The Year of the Secondary” has simply been delayed, rather than over-hyped. For one thing, the ongoing restructuring of the global banking sector looks likely to give rise to some significant secondaries buying opportunities. Whether forced by regulation or not, banks are expected to start reducing their exposure to private equity during 2010. Secondly, as we have seen, deal activity is returning. The associated drawdowns could yet cause liquidity issues among LPs, who would then become another source of deal flow. There are also hopes among secondaries investors that a number of high value deals – in the $500 million-plus category – will account for a large chunk of the committed capital.

With a little luck and timing, therefore, this bubble could be deflated before it floats out of reach. The question, as ever, is what to buy. Undrawn primary funds that are bidding high on assets such as Pets at Home? Secondary buyers, beware.