Melwani: Strong fundamentals, leverage caps make this cycle different

Debt is cheap, private equity firms have almost $1 trillion of dry powder on hand and purchase-price multiples are as high as they’ve ever been.

This cycle is different, however, Blackstone Group CIO Prakash Melwani said at Columbia Business School’s 23rd Annual Private Equity & Venture Capital Conference on Friday.

Melwani, who joined Blackstone in 2003 after co-founding middle-market firm Vestar Capital Partners, characterized previous market downturns as being precipitated by overzealous lending strategies that levered companies by eight or nine times their annual earnings.

Federal guidelines implemented following the passage of Dodd-Frank in 2010 have kept banks from lending at more than 6x EBITDA.

While cheap leverage is enabling buyers to increase the size of their bids on new companies, the federally mandated cap on leveraged loans means “the increase in valuations this time around is much more fundamentally driven,” he said. “This cycle actually is different in that way.”

The economy appears to be on solid footing and portfolio-company earnings will likely rise under new tax rules signed into law by President Donald Trump late last year, further encouraging buyers to pay up for portfolio companies, Melwani said.

Some PE investors are beginning to express concerns about the current investment climate.

Average purchase-price multiples on new buyouts exceeded 10.5x last year, according to S&P data cited in a recent report from TorreyCove Capital Partners.

Even with a solid pipeline, State of Wisconsin Investment Board’s private equity co-investment team is proceeding with caution, citing the rise in valuations and use of leverage.

While the headline numbers around dry powder, valuations and leverage are scary, the opportunities Blackstone is seeing in the large-cap buyout market “are really interesting right now,” Melwani said.

“When people talk about dry powder, I think it’s a very simplistic way of looking at the industry,” he said, adding that valuations are rich. “Opportunities aren’t monolithic. Industries aren’t monolithic. You have got to really segment where the opportunities are.”

Blackstone, which closed an $18 billion flagship buyout fund in late 2015, has been particularly active pursuing opportunities in the energy sector, concentrating on exploration and production  companies, as well as oil-centric midstream investments in U.S. shale regions.

“It’s a voracious user of capital,” he said. “Public equity markets are largely shut to E&P companies. The debt markets … you can’t borrow. So you have these voracious users of capital who are shut out of the debt and equity markets. [It’s a] wonderful entrée for private equity.”

In April, Blackstone acquired EagleClaw Midstream Ventures from EnCap Flatrock Midstream for about $2 billion. The firm invested roughly $7 billion in natural gas-related drilling and gas production as well, the Wall Street Journal reported in August.

Blackstone Group had $434 billion of assets under management as of Dec. 31, $105.6 billion which was held in private equity assets. The firm’s investment platform also includes real estate, hedge fund and credit programs.

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Blackstone CIO Prakash Melwani (right) at Columbia Business School’s private equity conference on Feb. 23, 2018, in New York City. Photo by Buyouts Staff.