Editor’s Letter: Nervous dealmakers; hyper LPs

A familiar refrain echoed through the brightly lit rooms of the Hyatt Regency in Boston in March.

Prices are high, said dealmakers at Buyouts’ PartnerConnect East conference on panel after panel. They’re so high that the environment is starting to feel like that golden era back in 2007.

GPs are underwriting deals to mid-teen IRRs, which some panelists at the conference said was an unrealistic outlook considering the high prices on those deals.

And the days of cheap credit seem to be going away as the Federal Reserve raises rates. At the same time, investors can’t rely on macro growth, which has remained relatively stagnant in the U.S.

All this means GPs have to roll up their sleeves and get their hands dirty to create value in companies in which financial engineering won’t lead to returns.

One way to do it is to have an angle, an industry focus “where you know more than someone else,” said Scott Galletti, managing director at Tenex Capital Management.

Galletti said Tenex has stayed active despite high prices because opportunities to deploy capital are still out there.

The current environment feels similar to the heady days of 2007 in that “all of a sudden you can’t get a meeting unless you pay 9x,” Galletti said. “My margin of safety is gone at 9x.”

GPs are doing a lot more work up front in early due diligence to figure out what kind of angle they can bring to a deal in which they are paying a high price, David Felts, a managing director with TM Capital, said on a panel.

Kenneth Clay, founder and executive managing director of Corinthian Capital Group, said the higher cost of debt makes it harder for GPs to pay high prices and still make money. “When the cost of capital is almost free, you can pay more. … That show has come to an end,” Clay said. GPs also can’t rely on macro growth, he said.

It’s a tough environment to work in, but PE firms have to deploy, considering the huge amount of capital that is waiting on the sidelines.

Overlaid on this environment is uncertainty about what might come out of Washington. Panelists said LPs, lenders and portfolio-company executives have been asking about the future of things like healthcare and international trade.

“You have to maintain discipline,” Clay said. “Investors are paying you a management fee to invest capital and do so wisely.”

But as dealmakers talked about finding value in a frothy market, LPs spent time talking about how to access oversubscribed funds. A handful of GPs in the market see heavy demand from investors and allow in only a few new LPs. These firms can pretty much raise their funds through existing investors and have no need of even marketing.

Firms like this can pick and choose LPs and can dictate terms. It’s an interesting dichotomy — deal makers nervous and cautious about spending LP capital and LPs scrambling to access expensive funds that are as much as doubling in size from prior vehicles.

Where is it all heading? someone asked. No one knows, but a lot of people seem nervous.

Private Equity Editor Chris Witkowsky reflects at home. Photo by Wendy Witkowsky