Finance
PRIVATE EQUITY, BANK LENDING AND EMERGING MARKETS
This year the global economy is forecast to grow at a rate +4.4%. The banking industry, however, is still in the recovery ward and under close observation in case of a relapse. Encouragingly, events in Ireland and Egypt have failed to unsettle market equilibrium and so perhaps we may be past the worst.
D
uring the period of easy access to funds between 2005 – 07, the Private Equity industry became synonymous with complicated highly leveraged deals. Now it has been forced back to basics - fi nd good companies with potential and invest at the right price. The only difference between
public and private equity investment is that you need to be more careful with the latter, because once committed it is harder to get out. By mid 2009 it was becoming clear that the environment for investment in private equity was starting to improve despite the constant stream of bad publicity. The soap opera, formerly known as EMI, is just the latest in a long line of PR disasters. Of course the Private Equity industry will need to downsize as the pre-credit crunch excesses are unwound and there are bound to be more hubristic deals hitting the buffers. Investors should not, however, be distracted. Along with a contrarian frame of mind one of the keys to successful investment is knowing when to stop agonising about the problems of the past and move on. Now is the time to consign the excesses of the pre credit crunch world to the archives. This year the global economy is forecast to grow at a rate +4.4%. The banking industry, however, is still in the recovery ward and under close observation in case of a relapse. Encouragingly, events in Ireland and Egypt have failed to unsettle market equilibrium and so perhaps we may be past the worst. Bank lending is critical in making the case for investment in private equity, but not for the reason that might fi rst spring to mind – a return to excessive leverage. So far the banks have only used the insolvency process for their worst cases. Instead, loans have been re-priced and extended in the hope that better economic times are ahead. This approach worked reasonably well in 2009 and 2010, but there is increasing evidence that lenders are now looking for a more permanent solution and this will require new capital. Private equity investors are ideally placed. Despite the recently announced efforts of the UK Government to encourage bank lending, the net effect is unlikely to be signifi cant. Long standing relationships between companies and banks have been damaged by what the companies see as over charging and the arbitrary withdrawal of support at a time of need. As a result there will be opportunities to invest at the right price across a broad range of companies. Those that are in a growth phase and need capital to expand and good companies with weak balance sheets, but otherwise operationally sound. Exactly the same valuation techniques apply as when identifying attractive equities listed on the stock market. It should not be forgotten that UK and Irish banks are the UK’s largest economic
owners of hotels, commercial property, house builders and retailers. Banks have neither the skills nor structure to manage their way out of these positions. These reside elsewhere which is why we are seeing the return of trade buyers. Although the banks are supportive, external fi nance is needed and again this is an opportunity for private equity. Investors willing to provide risk capital should expect returns in the range of 15 – 20% per annum after fees and carried interest. The liquidity crisis will be long and hard with the impact felt for many years to come.
The UK economy and its banks are holding excessive levels of debt and equity risk and need to de-gear as quickly as possible. This will be achieved by a change of ownership in favour of those with fresh capital to commit. Opportunities started to emerge in 2009 - 10 and we were able to invest in several private companies, backing two agreed
38 cywinter 2011
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