Buy low, sell high and use leverage to boost the returns. That was the recipe used by the private equity industry during the glory days in the late 1990s. The current situation could be caricatured more like buy high and sell low – that is, if you can find an exit at all.
So much money is sloshing around the industry that it is hard to get a bargain. Big businesses put up for sale – such as QwestDex in the US or France's Legrand that are currently on the slab – are auctioned off in highly competitive contests that pit private equity houses against each other.
As for exits, the blight in the IPO market has made it pretty tricky to squeeze through that window. Private equity groups that don't manage to float their investments may well have to pump in more cash. Even those that do – such as Texas Pacific with the revived float of Punch or Industri Kapital with Alfa Laval – find they can't take much if any cash off the table. The IPO market may not be any worse than it was last year, when it was virtually dead. But that's scant comfort. The high hopes invested in a spring revival have been dashed.
M&A exits aren't doing much better – despite 3i's extremely profitable sale of Go to Easyjet last week. Chief executives' animal spirits are mostly low. They don't want to splash out on transforming deals.
Indeed, the lack of traditional M&A exits is persuading many private equity houses to scout around for 're-tread' opportunities, where one private equity player sells a business onto another. For example, Doughty Hanson is reportedly interested in acquiring Priory Healthcare, a UK network mental healthcare clinics, from Goldman Sachs' real estate arm for £295m. But such a game of pass the parcel doesn't look a terribly promising way of delivering good profits except in the odd case.
There are silver linings. Most obviously, weak markets ought in time to allow private equity houses to buy assets on the cheap again. Indeed, many companies – especially in the TMT sector – are so desperate to cut debt that they could become distressed sellers.
Moreover, capital will probably eventually be removed from the industry, so cutting competition. This is more likely to involve investors refusing to put up new money for houses that haven't performed well than actually yanking cash out of funds. There will be a process of separating sheep – like Cinven which completed a E4.3bn fund last month – from the goats. That said, this will not happen quickly. Meanwhile, it will be a grim time.