August 1, 2019
Private Equity: Other People’s Money? Not So Much These Days. . .
Rising stock prices may be good for your 401(k), but this WSJ article says they’re putting the squeeze on private equity funds:
Rising stock valuations are forcing private-equity firms to contribute more cash to their leveraged buyouts. That is likely to drag down performance in the long term even as pensions and other investors increasingly turn to private equity to boost returns.
Private-equity firms contributed 52% to the purchase prices of companies they bought in the second quarter of the year, according to data from research firm Covenant Review, a unit of Fitch Solutions, up from 45% in the first quarter. That compares to an average of 47% and marks the highest quarterly figure since Covenant Review began tracking the data in January 2017.
The problem is that while the rising stock market is driving equity valuations higher, banks are still not willing to lend more than 6x EBITDA, which leaves PE funds with a gap that they need to fund with equity if they want to play in today’s deal market. Because the magic of private equity is using other people’s money to leverage your own capital & generate higher returns, the need to use more equity means the returns to private equity investors are likely to get squeezed.
Since private equity has driven so much M&A activity in recent years, does this potential squeeze on returns mean the party’s over? Maybe, but then again, this isn’t the first time PE funds have been forced to pony up more equity for acquisitions. In fact, it’s not even the second time. . . or the third time. . .
– John Jenkins