Private equity firms will propel deal-making forward in 2012 as they race to put vast sums of ageing “dry powder” to work before investment periods expire, but could face strong headwinds, according to a latest report by Bain & Company, the world’s leading advisor to the private equity industry.
In business, dry powder refers to cash reserves kept on hand to cover future obligations or purchase assets, if conditions are favourable.
According to the report, uncertainties in the economic outlook and volatile equity markets will make it difficult for buyers and sellers to agree on price. Bain finds that debt-market conditions were less favourable at the start of this year than in 2011.
One major concern is whether the supply of debt will be able to keep pace with demand, even if deal-making picks up. The authors say though, that it’s likely that credit markets will remain accommodating as long as the hunt for yield in a low interest rate environment continues to draw investors in.
“The Middle East private equity market is currently in its infancy. At present, it consists mostly of growth capital, relatively small equity tickets invested in minority stakes of small- and mid-size companies and is largely opportunistic across sectors and geographies. Fund raising is still a major challenge as well as exits of existing assets,” Jochen Duelli, a director in the Dubai office responsible for the private equity/corporate M&A Practice Group, said.
“Due to the scarcity of attractive targets and the large amount of available dry powder of $5-$9 billion, competition among funds is huge. This issue is compounded by the mismatch of sellers and buyers price expectations. Many general partners [GPs] have not yet completed a full investment cycle and thus may struggle in the next few years. A few, more powerful GPs will remain.”
“Private equity firms [GPs] will feel pressure to unload assets in 2012,” said Hugh MacArthur, head of Bain & Company’s private equity consulting practice and lead author of the report.
“They have been slow to return capital to investors [LPs] since the downturn, and the exit overhang has grown to nearly $2 trillion globally.”
Adding to the pressure to do deals is the fact that a sizeable portion of the dry powder earmarked for buyouts — 48 per cent of the total — is held in funds raised during the big 2007 and 2008 vintage years.
“The clock is ticking loudly for these funds,” said MacArthur. Unless that capital is invested by the end of 2013, GPs may need to release LPs from their commitments and forego the management fees and potential carry it could generate, according to the report.
Burning off the ageing dry powder will likely result in too much capital chasing too few deals throughout 2012, as GPs that manage the older vintages compete with one another and with GPs of more recent vintage funds to close deals. Indeed, if buyout activity remains at the modest levels of 2010 and 2011, the dry powder from the 2007 and 2008 vintages alone could fuel the deal market for 1.8 years.
That pressure will be even greater in Western Europe, where funds are sitting on an even larger proportion of dry powder nearing its “use by” date.
But do not look for exit activity to perk up in 2012, the Bain report said. Weakness persists across all exit channels, and many companies in PE fund portfolios are still not “ripe for sale,” held at valuations below what GPs need to earn carry.
Fast-growing emerging markets continue to attract both LPs and GPs, but most will be challenged to meet their high expectations. LPs are captivated by robust emerging market growth and continue to pour money into these regions, but to-date, the long-awaited potential has failed to materialise to the extent investors had hoped, according to the report.
Fund-raising is not poised for a recovery in 2012. The slower pace of exit activity is leaving liquidity-strapped LPs strained to meet capital calls for past commitments, and volatile equity markets are pressing them against their PE allocation ceilings. Meanwhile, an oversupply of funds seeking capital could force GPs to scale back lofty expectations or face being disappointed.
Khaleej Times
