A recent Bloomberg report provides an interesting analysis of the state of returns from the buyout sector. According to the cited data, limited partners are not getting much back for their money, and the problem looks set to continue.
The ultimate cause, you won’t be surprised to hear, is the end of the cheap money era, which obviously had much more to do with the current size of the sub-asset class than many buyout proponents would care to admit. Debt for new deals is more expensive. Loan repayments on existing deals, many done on a floating-rate basis, are more and more burdensome. And higher interest rates mean that competing asset classes, such as long-neglected bonds, are now far more attractive propositions for investors.
Proximally, buyout firms are running into trouble trying to exit their current holdings while continuing to try to draw down money from LPs for new deals. The report quotes analysis from Burgiss Group LLC showing that in the third quarter of 2022, the ratio between money in and money out hit its least favourable level since the depths of the global financial crisis in 2008. That’s a negative cash flow of over US$40 billion.
In almost every business sector, according to figures from Preqin quoted by Bloomberg, private equity exits in the form of sales of investee companies look likely to end 2023 at half their 2022 total at best. The problem appears to be valuations, which are hard to determine while interest rates are still fluctuating. Moreover, the floating-rate debt weighing down many of these buyout acquisitions makes some of them very vulnerable to high interest rates, and burdened with legacy issues that need to be sorted out before they can be sold.
One might also query the valuations of the original deals, which often were driven up by competitive bidding between cashed-up private equity funds. That certainly seems to be a reason behind the fall-off in private equity secondary exits, where funds sell businesses to each other.
Meanwhile, the initial public offering markets remain more or less closed to private equity exits. Dealogic figures quoted by Bloomberg show no major private equity backed listing since the last quarter of 2021.
If this is the picture that LPs have been seeing, then no wonder the latest Coller Capital report shows that big buyouts are expected to be the least attractive sector in the asset class for the next couple of years.
It remains an open question whether the industry is just going through a brief hiatus, or a reset of its operating conditions that is going to leave many buyout firms over-extended and unable to sustain the growth momentum of the past couple of decades.
