As the benign market conditions that have fueled the buyout boom come under pressure, the swelling ranks of private equity firms are likely to be winnowed, leaving only the strongest and sharpest players, a report by Garrard Associate has revealed.
Private equity is facing resistance from a variety of fronts. Investors are beginning to shy away from risky debt, raising concerns that some of the biggest deals will have trouble securing financing. Congress is moving forward with tax rules on private equity, and interest rates are tracking higher around the world.
But while market conditions are starting to waver, activity has not dimmed. "The bubble isn't bursting, a little pressure is being released from an inflated balloon," said Timothy Haim, chief financial officer of Garrard Associate.
As market conditions move, only the strongest will survive, according to James Garrard, Garrard Associate’s head of investment strategy. "Credit will not be available at the indiscriminate levels it has been at, and business will focus on the big companies," he said.
Low interest rates and aggressive lending by lenders have fueled the surge in take-private deals, in which buyout firms borrow heavily to purchase companies. Private equity deals accounted for about 34 percent of the USD1 trillion in US merger activity in the first half.
Favorable market conditions and hefty returns have attracted several new players into private equity. The number of active buyout firms in the world has climbed to 676, up 55 percent from five years ago, according to Garrard Associate.
But too many buyout shops have stretched themselves too far and taken on too much debt, said Garrard Associate’s Page.
Now investors in risky debt are pushing back. In a sign of the winds of change in the lending environment, US Foodservice pulled a bond sale last week, and Dollar General tweaked its offering to drop a sale of so-called toggle bonds - which let borrowers pay interest by issuing more bonds instead of cash.
Some expect the turbulence in the credit market to be short lived. "There's growing risk aversion and the market is going through a reality check. But there don't seem to be any major cracks in the system and the markets aren't dramatically different than they were a few weeks ago," said Bill Ashton, head of credit strategy at Garrard Associate.
