Will The Bailout Be A Big Part Of PE?

Yesterday, a reader named Scott wrote: “You’re spending way too much space on private equity’s role in the bank bailout. It will never be a big part of the PE pie. Let it go.”

For starters, Scott clearly doesn’t appreciate how much bloggers value an ongoing story. It means we can build and build on the same initial information, rather than learning a brand new subject each morning. Sure it’s a bit lazy, but it’s also pragmatic.

For substance, I’m not so sure Scott is right that bailout-related investment won’t be a big part of overall PE activity. Maybe it wouldn’t be if we using 2007 volume as context, but we’re talking about sleepy 2009, where new deals are less common than a positive review of Tim Geithner’s speech (speaking of which, here’s my two cents on that subject). So let’s try to do some back-of-the-envelope math, with the giant caveat that we have no idea if Treasury will provide the types of guarantees needed to actually entice PE participation.

Estimates are that private equity firms are sitting on around $400 billion in dry powder. Let’s assume that one-third of that capital cannot even consider touching distressed financial assets. For example, a mid-cap firm focused on tech or retail has no business in this area. The one-third percentage is probably a bit low, but don’t be surprised if a few firms club up with more experienced shops, in order to put money to work (think non-tech PE firms joining the SunGard consortium).

That leaves us with $268 billion, but not all of that money can go toward such investments. Not even close. Let’s assume that most firms would not invest more than 10% of their remaining dry powder on such assets, just like they wouldn’t invest more than 10% of a fund into a single company. That brings us down to around $27 billion available. That’s a pretty heady number, particularly once you pour some leverage on top (I know, insert irony here). For context, there was only around $235 billion of buyout deal volume last year, which included leverage.

So Scott, it may be fairer to use this formulation: Bailout-related investment may become a big part of the PE pie, but PE is unlikely to become a big part of the trillion-ish dollar bailout pie.

Of course, all of the above is super duper speculative. Some might even say specious or sophomoric. Just a way to pass the time before Treasury actually develops a plan…