This column was originally published on RealMoney on Mar. 3, 2008 at 3:52 p.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.
From 2004 right up until the first two weeks of August 2007, it was widely assumed that there was a
private-equity put in the stock market. Any time
valuations fell to a certain level, it was just assumed that the funds, flush with cash and the ability to obtain almost unlimited
leverage would swoop in and bid the shares back up.
You know what? There was, and I have to confess, I miss it. It was a lot of fun. All you had to do was put together a portfolio of stocks that generated
free cash flow, had small amounts of debt and sold for less than five
times enterprise value to
EBITDA, and you were going to get a lot of takeovers among your stocks.
Simply by paying attention to
hedge funds' and other activist investors' 13d filings, you could pretty much see in advance where the private-equity money would show up next and position yourself accordingly.
The End of the Good Old Days
Of course, after August, the game changed, and quickly. First, financing dried up almost entirely. It was no longer possible to put up a few hundred million and borrow several billion to buy companies. There would be no more talk of levering up a company's
balance sheet, taking out a special
dividend and letting the
cash flow pay off the debt for a few years before you took the company
public again. Those days were over.
Also, as the economy began to falter, the days of portfolio companies running on autopilot also came to a crashing end. Rather than merely looking for new deals to fuel
returns, it became necessary to actually pay attention to companies you already owned. The party was, if not over, a lot more subdued than the glory days.
There was a private-equity conference in Germany this past week, the 11th annual Super Returns Summit. For a conference where the attendees controlled so much money, and their thoughts and attitudes have such a strong affect on stock prices going forward, it was pretty lightly covered by the mainstream business press. Some of the largest private-equity funds were represented, and they had a lot to say about the future of deal-making and where the money would be made, and perhaps more importantly, would not be made in the years ahead.
, the managing director and founder of Carlyle Group spoke on Wednesday
Feb. 27 and set a somewhat somber tone for the industry. He thought it would be at least 2011 before peak times returned to the private-equity game. He also said it would take a while for leverage to become a part of the buyout process for some time, as banks, stung by being unable to syndicate and sell loans from 2007 leveraged buyouts, were still dealing with losses form those transactions.
He feels that minority stakes in
emerging-market companies were going to be a source of private-equity returns over the next few years (see "
"). He also offered a ray of hope when he pointed out that many of his best-performing previous deals were bought in times of distress. If prices are low enough, he told attendees, you don't necessarily need leverage.
Going After Debt Rather than Equity
Buying in times of distress was a common theme among speakers in Frankfurt this past week. Leon Black of Apollo Management talked about buying up the
debt of companies rather than the
equity of companies as a source of profits in the next several years. "It is all about value creation," said Black."
You can get equity-like returns from debt instruments that may be a better play than pure equity right now when you cannot get leverage. Ironically, much of the debt he was talking about was from private-equity deals in earlier years that had pushed companies into financial distress when the economy began to slow down this past year.
Getting in the Clear
Most of the speakers struck the same tone and there was a general feeling that it would be a year, perhaps two, before the debt logjam began to clear and the banks would be comfortable lending again.
In the meantime, deals will be much smaller than in 2006 and 2007 and a lot more attention will have to be paid to actually running the companies they buy. The party is over in this space, but everyone seems confident that once the hangover clears, a new one will begin eventually.
The Investment Angle
What does that mean for us, the regular investors who cannot leverage up 10:1 and buy whole companies? Quite a lot actually. The "private-equity put" is gone, so we need to be more selective about the quality of the stocks we buy. It is no longer viable to just assume someone else will come along and buy our stocks at higher prices. A large amount of the
capital devoted to those purchases has dried up and blown away with the economic wind.
It may also start to make sense to pay attention to the debt prices of companies we are interested in buying. It might be that the debt has fallen to levels that are more attractive than buying the stock. That used to be a tricky game, but with Nasdaq Trace giving transparency to
corporate bond pricing, it is a much easier game to play on a much more level playing field than days gone by.
Lastly, keep an eye on some of the publicly traded private-equity firms, such as
. There will come a time when capital is washed out of the field and the survivors will be able to earn extraordinary returns once again. When they do, you will want to own these stocks.
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At the time of publication, Melvin had no positions in the stocks that are mentioned although positions may change at any time.
Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback;
to send him an email.