These Sovereigns Are No Ladies: PE and the Global Crisis

First: Yes, that headline is a Britpop reference to U.K. rapper Lady Sovereign. There’s a PE connection: Ms. Sovereign is, after all, signed with EMI, a label (barely) still owned by Terra Firma.

Just as Ms. Sovereign’s label is in a crisis, so too is much of the European continent. We have irate Germans, rioting overworked Greeks, belt-tightening Iberians and the prospect of the French storming away from the dinner table in a huff.

Surely this must mean something for private equity. Perhaps the potential for collapse of entire currencies will change the whole game.

Blackstone Group boss Steve Schwarzman was the only buyout pro this week to discuss the effect of the sovereign crisis publicly. In Toronto, he explained that Blackstone has shunned Europe recently because of high prices (and no doubt the unfavorable dollar-euro exchange rate) but that the firm might re-examine the Continent. “What I have found in life is that when the environment changes and people recognize that there are issues, that valuations over time tend to drift down, which might make it more interesting for us.”

It seemed to us that private equity would get off too easy, so we asked some other private equity professionals and lawyers for areas that private equity should keep an eye on. Here are some ways in which “geographical risk,” as the prospectuses say, may affect buyout activity over the next few months.

Even less ability to borrow
European banks in countries like Italy, Spain and Greece are just as troubled as their governments. This could impact financing. UniCredit, for instance, said this week it has 31.5 billion euros of exposure to Italian government debt and another 1.5 billion euros to Greece, Spain and Portugal combined; UniCredit is considering selling its Pioneer asset management unit or combine some of its businesses with another bank, according to the Financial Times. Even among the international banks, lending has been tight and the junk-bond market in the U.S. and Europe looks dangerously overpriced.

Fewer deals
Private equity activity has been trending precipitously downward for over two years. Even before the sovereign crisis was widespread, Roland Berger consultants were expecting a 40% drop in private equity investing this year in Europe. European private equity was already considered in its “adolescent” or “teenaged” phase compared to the more mature industry in the United States. The sovereign crisis might further stunt its growth with uncertainty and distracted governments that may hold up deal approvals.

These come in waves in Europe every few years anyway, and the last cycle was around 2005. As governments become unable to support state companies, they may put up stakes or entire companies for sale. The U.K. has already done just that by proposing to sell some of its stakes in domestic banks to raise as much as $116 billion. Similarly, sectors like infrastructure – which depend on public-private partnerships – may see an uptick in dealflow as governments invite more private investors in. (But watch out for a wave of regulatory probes, particularly in the U.K.)

Regulatory risk
The European Union is already making plans to rein in private equity funds and hedge funds. Once the government ball is rolling, it doesn’t usually stop. A sovereign crisis might make those funds attractive targets for higher taxes.

It all seems very uncertain, but this is one area where private equity’s long-term investment horizon of three to seven years actually comes in handy. In that time, either everything will have blown up or it will have blown over. Either way, the current worries are sure to be resolved. On the bright side, limited partners aren’t running away yet.