In the first half of 2007, private equity firms were making frequent purchases and pulling in substantial profits. While equity firms are still raising impressive amounts of capital for their investment funds, tight credit market conditions are forcing large buyout shops to consider new strategies. In today's economic climate, private equity buyers are pursuing smaller deals and seeking new markets.

A New Investment Climate

Private equity firms typically buy companies - mostly with borrowed money -with the goal of improving their business operations and then selling them at a profit or taking them public, usually within three to five years. But the pace of private equity buyouts has slowed dramatically since the summer of last year. So far this year, buyout deal volume has reached just $82 billion worldwide, 68 percent less than the nearly $261 billion seen during the same period in 2007, according to deal tracker Dealogic.

The pace of fundraising in the private equity sector has also slowed. The average time spent raising cash for funds that closed this year was 14.2 months, nearly 50 percent longer than the period for funds closing in 2004. There are currently 1,478 funds seeking an aggregate of $844 billion, compared with 1,304 looking to raise $705 billion in January 2008. Even so, private equity firms are still raising money - in the first quarter of 2008 the sector raised nearly $164 billion in funds, according to research firm Private Equity Intelligence. The present level of fundraising suggests a total of $75 billion for 2008, ahead of the $59 billion total for 2007.

But in order to finance large acquisitions, private equity companies still need to secure funding from banks. The crash of the subprime mortgage market has made easy credit a thing of the past, as banks negotiate for more tightly controlled lending agreements. A number of 2007 deals have run into difficulty closing because the private equity buyers could not secure financing commitments from lenders.

The proposed $48 billion purchase of Canadian phone company BCE Inc. by a consortium of private equity buyers provides a current example. The banks arranging the financing for the deal are pushing for tougher terms than were originally contemplated when the deal was announced last June. In a similar situation, a contentious fight over financial terms led to Clear Channel Communications selling at a lower price and with slightly higher lending rates than originally negotiated.

Target companies are also more hesitant to accept takeover offers from buyout firms. Corporations are aware of how much they could have sold for last year and don't want to sell for a reduced price simply because the market has become more difficult. And having seen private equity deals come apart over financing issues, sellers want more reassurance that equity firms have the credit to complete their transactions.

New Strategies

In recent years, equity buyout shops have pursued large deals, often combining their resources to make purchases they could not afford individually. This year, however, private equity firms have increasingly targeted smaller acquisitions. According to Dealogic, buyouts announced worldwide so far this year have averaged $210 million in size, less than half of what the average was in 2007.

In 2007, Kohlberg Kravis Roberts, TPG Capital, and Goldman Sachs offered $44 billion for utility firm TXU Corp. while Blackstone Group acquired Hilton Hotels for $26 billion. This year, Bain Capital announced plans to buy Bright Horizons Family Solutions, a provider of employer-sponsored child care, for only $1.3 billion. Blackstone Group is working with Wellspring Capital Management to purchase Performance Food Group for $1.3 billion.

Buyout firms are also pursuing emerging international markets. Investments in Asia are growing, particularly in China and India. Latin America, Africa, and the Middle East are also attracting interest from investment firms.

In the past, the private equity sector has viewed emerging markets as higher risk investments, but now international markets may present an attractive alternative to pricey domestic buyouts. While difficulties with bank financing present a challenge to deals in Western markets, deals in emerging markets often rely on cash or local banks less exposed to the global credit crunch. In a survey conducted by the Emerging Markets Private Equity Association, 74 percent of private equity participants stated that they expected to increase commitments to emerging markets over the next three to five years. · ·??

Private investment companies are also pursuing other investment opportunities beyond acquiring businesses. A number of equity firms, for example, have begun playing landlord, buying up apartment buildings and seeking returns on their investment from collecting rent. In New York, thousands of rent-regulated units across the city have been purchased by equity investment firms, hoping to raise prices that have been kept under market levels when tenants vacate.

Outlook

There is no question that times are harder for private equity firms. Slower fundraising and a tougher credit market are making the large and profitable deals common only a year ago much more difficult now. But the private equity sector still has money to spend and is adapting to the new economic climate. The future for private equity will likely hold smaller deals, more careful credit negotiations, investments in emerging international markets, and investments in alternative business opportunities.

Source: Chicago Tribune, CNNMoney, M&A Insight, New York Times, Reuters

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