When I won the PE Wire NCAA tournament pool last year, no one was more surprised than me. I grew up in New York City as a rabid Knicks fan with minimal interest in college basketball. Despite my lack of experience, I accurately forecast the final score of the 2007 National Championship with an 84–75 Ohio State victory over Florida State. As Dan Primack began to organize the 2008 PE Wire NCAA tournament, I received a flurry of e-mails from friends and colleagues about my strategy this year. Who was in my final four? What would be the big upsets? What would the final score be in the National Championship? Clearly many of my colleagues had more than just pride on the line.
So how did I do in this years’ tournament? Of the roughly 300 participants, I finished near the bottom. How could I go from being phenom to failure in one short year? Put simply: Everything I learned about college basketball in 2007 was wrong in 2008.
My old strategy relied heavily on picking favorites—a winning approach when there are relatively few upsets. But in 2008, my strategy failed as upsets abounded, including two #4 seeds losing in the first round (though, as my colleague reminded me, this was the only year in history where all top-seeds made the Final Four).
My college basketball experience made me wonder if everything I learned in private equity in 2007 was also wrong in 2008.
My day job, when I am not handicapping collegiate sports, is to find investors who need liquidity for their investments in LBO and VC funds. As such, I speak with countless individuals who have been investing in private equity for years. The contrast between what I have heard from these investors last year and this year is startling.
Here are four “facts” from 2007 that have been wrong in 2008:
Wrong Fact #1: Investors have an insatiable appetite for buyout debt
Q1 2007: Buyouts Magazine Headline: “2007 Deal Pace Builds As Players Downplay Risks”
Q1 2008: Buyouts Magazine Headline: “Secondary Market Distracts Investors from New Deals”
The lack of debt markets for private equity transactions has been one of the biggest changes from 2007 to 2008. An article in the April 2007 issue of Buyouts Magazine described the first quarter of 2007 “as one of the busiest quarters ever in terms of buyout deals closed.” The market was ripe with lenders willing to support ever-larger deals. One year later, the market is markedly different. An article in the March 2008 issue of Buyout Magazine describes how difficult it is to finance a mid-market buyout transaction. At the same time, mega deals have disappeared to the point that they seem like relics of a distant past.
Wrong Fact #2: The economy is stable and growing
Q1 2007: Bear Stearns Market Cap: $19.4 billion
Q1 2008: Bear Stearns Market Cap: $1.4 billion
There are a multitude of examples of collapsing financial institutions in 2008, but none is quite as awe-inspiring in its speed or magnitude as that of Bear Stearns. While Bear Stearns has a limited direct impact on the private equity industry, it is indicative of the fragility and volatility in the current economy. U.S.–based buyout deals in the past year have occurred largely in a stable and growing economy—that is certainly no longer the case.
Wrong Fact #3: Buyout transactions have a nearly unlimited universe for take-private transactions
April 2007: WSJ buyouts coverage focuses on increasing number of take-private transactions
April 2008: WSJ buyouts coverage focuses on collapse of Clear Channel buyout
One of the frequent comments I heard in 2007 was that there was a near-limitless universe of public companies that could be taken private. Somehow in the last year that universe has dramatically shrunk and the news tends to be more around what deals have collapsed rather than what deals can get done. Take-private transactions from 2007 that have been abandoned in 2008 include PHH Corp, Myers and Affiliated Computer Services.
Wrong Fact #4: Private equity funds can raise near limitless amounts of capital
Buyout fund capital raised: down 20% year-over-year in Q1 2008
(statistics based on Dow Jones release dated 4/7/2008.)
2007 was a record year for private equity fund raising. If Q1 is an indication of the year to come, 2008 could be beginning of a deceleration in the pace of fund raising. Funds are still closing, but at a much slower pace. In a high profile example, Blackstone Group delayed the scheduled close from their latest buyout fund from mid-April to early June. In a remarkable change, the largest Private Equity fund closed since the start of the year was the $20 billion Goldman Sachs Mezzanine fund—a fund that should be more isolated from problems in the credit markets.
The purpose of this post has not been to reflect on the year in basketball (though it certainly was fun), but rather to highlight the fact that there is a legitimate reason for investors in private equity to reassess their strategies for investing in private equity in this new economic environment. I have spoken with many institutional investors (mainly pension funds and financial institutions) who worked hard in 2007 to meet increased private equity allocation mandates. These same investors are now often concerned about potential over-exposure to the asset class. Some particularly savvy investors are selling a portion of their private equity holdings while times are still relatively good in private equity. Secondary buyers such as my firm are able to help these investors to diversify their asset base and rebalance their portfolios.
The 2008 NCAA tournament taught me that what worked in 2007 may never work again. Private equity investors may be beginning to learn the same lesson.
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