Year-End Private Equity Writedowns Ahead

NEW YORK (Reuters) – Private equity firms will soon announce major year-end write-downs to their portfolios as recession bites, but some think the accounting cuts won’t go far enough.

Private equity insiders are expecting write-downs of at least 20-30 percent as buyout firms revalue assets in a new world where unemployment is rising and consumer spending has fallen off a cliff.

Buyout firms that piled into businesses such as retail, real estate, carmakers and casinos have been particularly hard hit. U.S. buyout firm Apollo Management, for example, has investments in real estate broker Realogy Corp, retailer Claire’s Stores and gaming operator Harrah’s Entertainment Inc.

Consumer and retail was the predominant industry that the biggest private equity firms invested in during the five years to April 2008, according to a report from PEI Media.

Falling earnings from companies piled high with debt taken on during the bubble period of 2006-7 means firms will have to write down the values of those assets.

“We’ll probably see more write-downs,” said Josh Lerner, a professor specializing in private equity at Harvard Business School. “If we think back to the experience of the venture capital industry in 2001/2002 period, it had a lot of flavor of death by a thousand cuts rather than a big bang of definitive write-offs. I wouldn’t be surprised to see some of the same experience here.”

This is the first year that private equity firms are obliged to value their companies as if they were to sell them today. The accounting rule known as FAS 157 came into effect for financial years beginning after November 15, 2007.

“Transparency by and large is a good thing and that this is an industry that hasn’t had a tremendous amount of transparency historically,” said Lerner. “But the devil is in the details.”

Updates will be shared with the powerful pension fund and other investors in private equity funds, known as limited partners, in the coming months.

Most buyout firms have already been adhering to this, particularly those which are publicly traded like Blackstone Group (BX.N), or those with publicly traded funds.

Blackstone said when it reported third-quarter results in November that since the start of the year it had written down the value of about a third of the companies in its portfolio.

Kohlberg Kravis Roberts & Co’s [KKR.UL] publicly traded fund KKR Private Equity Investors LP (KKR.AS) (KPE) reported that net asset value, which tracks the worth of its investment portfolio, fell 22.6 percent at the end of September from the end of 2007.

STARK DIFFERENCE

The amount that private equity firms need to cut values by is evident when looking at the prices their assets trade at in the so-called secondary market.

The secondary market allows powerful investors in private equity funds, such as endowment and pension funds, to buy and sell their investments.

While the credit crisis put an almost immediate halt to leveraged buyouts the secondary market has been lively as large investors offload their exposure.

David de Weese, partner at specialist secondary firm Paul Capital, says pricing in the secondary market is at a 50-60 percent discount to the most recently reported fund values. He expects buyout funds to report reductions of 20-30 percent in carrying values of their portfolio companies for the year end, compared with numbers at the end of June.

Part of the discounts being bid by secondary buyers is due to the anticipated write-downs, he says, but also due to a supply-demand imbalance, with an estimated five times as much private equity for sale than dollars available to buy it.

Advisory firm Cogent Partners said in a recent survey that prices in the secondary market are at a 40 percent discount to the values reported by private equity funds.

Colin McGrady, managing director of Cogent, said that while write-downs of 20-30 percent would be appropriate, private equity firms would probably only reduce values by about 15 percent for the fourth quarter versus the third.

“Based on the secondary pricing, that’s likely under half of what’s needed to truly reflect the market value of the assets in the current environment,” he said.

(Reporting by Megan Davies; editing by Richard Chang) (megan.davies@reuters.com; +1 646 223 6112; Reuters Messaging: megan.davies.reuters.com@reuters.net)