Investment slide continues

The retrenchment of the European private equity industry has reached troughs not seen since Q3 1996, according to the unquote" Q1 2009 Private Equity Barometer, produced in association with Candover. It reveals that the total value of transactions fell by half against Q4 2008 to a shade over EUR4bn.

This continues the steep decline that set in following the Lehman collapse in September 2008. Indeed, despite showing relative stability between Q4 2007-Q3 2008, the figures have dropped off dramatically and the first quarter numbers are down by a remarkable 86% in value against the corresponding period of last year.

There is the temptation to see the volume figures as offering some slight consolation against the gloomy stats, with the Q1 total showing a much more modest 18% decline quarter-on-quarter from 267 deals to 219. The continuing implication is that the value decline is being exacerbated by the lack of larger deals as debt financing remains scarce, while there remains a resilient core to the market that has the capital and the confidence to invest.

However, the truth of the matter is that deal numbers have also slumped to lows not seen since Q2 1998, indicating that the aversion to new investments is not merely isolated to just the larger end of the asset class.

Bear buyout market

Unsurprisingly, the buyout space continued to decline at a faster rate to the market as a whole in Q1, with just 49 private equity-backed acquisitions completed over the three months, down more than a third on Q4 2008.

In terms of value the drop was sharper still, down by almost two thirds quarter-on-quarter to a little over EUR2.5bn. Buyout investment figures are now at their lowest level since 1992 and 1995 by volume and value respectively.

There was a complete absence of any deals valued at more than EUR1bn. Even core mid-market deals are currently very difficult to finance, with the broadly defined mid-market category, now covering deals worth between EUR100m-1bn, witnessing just eight deals worth a total of EUR1.6bn - volume down by a third and value by half against Q4 2008.

The small-cap range, covering deals worth less than EUR100m, also witnessed similar volume and value drops of 36% and 53% respectively against the previous quarter. However, the fact that 41 transactions were completed in this area does suggest that there are still those actively seeking deal opportunities. Indeed, many of these deals contained no leverage; a risky play that reinforces the confidence that some investors have in the profitable potential of some discounted assets on the market.

In terms of the regional breakdown, the ongoing crisis in the UK banking sector continued to stifle average deal size (now the lowest on the continent), which has pushed the value total down a further 25% to EUR252m - only the fourth highest overall. However, the country was alone in recording a modest increase of one deal in volume to 14, meaning it regained its historic pole position in activity terms. All other regions saw declines in both volume and value, with the DACH region perhaps faring worst - falling by more than 85% in value terms from EUR1.1bn to just EUR156m.

Bottomed out?

The question is: do these figures represent the bottom of the market? What is clear is that the predicted rise in attractive investment opportunities coming from stressed or distressed corporates and private equity firms or the public markets has yet to materialise, with the number of completed deals sourced from these vendor types all dropping over the three month period.

According to some, this is as much to do with uncertainty and trepidation over pricing as it is about leverage, as there remains no visibility on trading and some vendors have still to adjust to the new world order.

When this does begin to change, dealflow should again pick up, as there are certainly investors with cash to spend. But this could still be some way off, as trading performance is broadly still dropping across the economy. Furthermore, the ongoing problems many investors have with legacy deals, particularly given the stark exit market, is going to continue to take up valuable time and resources for months to come.

Is the current low a sign of a new paradigm, or merely a temporary

Josh Lerner, professor at Harvard Business School

"Private equity is an inherently cyclical activity. Given that the boom of recent years was of an unprecedented magnitude, it is not surprising that the bust has been very dramatic as well. One can make a compelling case that private equity activity will recover in the years to come. But it is likely to be a protracted process, and the industry that results will be a very different one from that of recent years"

Ian Armitage, HgCapital

"Clearly the cheque books have been locked away. No one needs to do a deal and until prospects improve why would you? Investors are behaving rationally, belatedly adjusting their stance to monumentally moronic government policies"

Jim Strang, Dunedin Capital Partners

"Given the credit market issue and the operating performance issue you'd expect new deal activity to be near zero. Even if you could get leverage it would be hard to convince yourself what multiple you'd actually be paying for any business - in some cases 6x 2008 EBITDA could look more like 8x 2009 EBITDA if you took Q4 O8 performance and annualised it. Moreover, for vendors with a quality asset Q1 09 didn't make sense in terms of being a good time to sell"

Philip Shapiro, Synova Capital

"These numbers come as no surprise as the restriction on the availability of credit has made completing big buyouts next to impossible. With no return to large scale lending likely for several years, the total value of completed deals will remain depressed, with volumes picking up at the lower end of the mid-market where leverage is still available"

Kevin Grassby, Bowmark Capital

"The level of inactivity in our market is as much driven by the mismatch of vendor and buyer value expectations as it is by the lack of availability of debt. When these expectations align (probably through a combination of movement on both sides), then we'll see to what extent lack of debt is really a constraint."

Neil Rudge, Royal Bank of Scotland

"We have certainly seen a reduction in completed deal volumes in the market during the first quarter of 2009 relative to previous years. We would expect this to be the case, as both vendors and acquirers take additional time to consider the impact of the current economic and financial climate. We have, however, noticed a pick-up in activity during the second quarter as the market starts to get to grips with these issues"

David Ascott, Grant Thornton

"Q1 2009 suffered from the perfect storm of a crashing Stock Market and the debt famine undermining investor confidence and creating a huge valuation gap between buyers and sellers. As liquidity improves and valuations come down there is a prospect of slow recovery in deal volumes, particularly at the smaller end".

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