Third quarter 2008: private equity crunch

How hard will the credit crunch hit private equity? This is the question practitioners across the industry have, inevitably, been asking. Earlier this year, the deal charts were difficult to interpret because of artificially increased activity on the back of tax incentives (seems an age ago!). Even the second quarter appeared to benefit from the tail end of this, with deals keeping going at a reasonable rate - albeit a disproportionate amount completed in the first five days and so before the end of the 2007/08 tax year on 5 April. It remained unclear whether the second quarter results were still a tax driven anomaly, or perhaps, just perhaps, the crunch was not coming to private equity?

Well, the resounding silence in the City during the summer - one could almost hear it, the streets were so quiet - and the statistics now that the third quarter is complete, demonstrate almost beyond question that what we were seeing was tax driven and anomalous, not a cause to hope that private equity would somehow escape the crunch. Across the board, deal numbers and aggregate values are dramatically down with even the expansion category, which of course includes "rescue" capital, not making up the ground. To illustrate the scale of change, we have produced a new chart this quarter showing activity versus the average for the corresponding quarters in the last nine years. But, first, let's look at the three sub-sets of private equity as we normally review them:

- First, larger buyouts (>EUR150m), for which we see just six deals in the third quarter out of a total of 33 for the nine months to date. If these volumes were repeated across the entire year, we would experience record-breakingly low levels of activity not seen since 2002/03. Aggregate values are just EUR3bn out of EUR17bn for the entire nine months.

- The same result is seen for smaller buyouts (

- The early-stage and expansion capital category is the only area of respite. 193 deals have completed in the year to date of which 48 were in the current quarter. Values are actually above average for the year at EUR1bn out of EUR2.9bn for the nine months to date. The surprise here is that there has not been more money put into shoring up investments - but perhaps that reflects the current economic woes starting in the macro financial sector and not yet having spread too deeply into the rest of economy. It will be interesting to see what this statistic looks like next quarter assuming recession starts to bite.

Optimists might say inactivity was a summer down-turn, not driven by the credit crunch. Others might hope they are right, but the unwanted answer is given in stark terms by the new chart showing the quarter just finished against an average of each third quarter for the nine preceding years. Every category, except aggregate values of expansion and early-stage deals, is at around half the average for the previous years. And, looking further into the detail, one finds there are not more than one or two periods in any category where the numbers or values are less than in the 2008 quarter just finished. This is, for the moment at least, particularly alarming for the private equity providers who are of course operating in a sector that has grown in terms of numbers of personnel as well as, until recently, numbers of deals. So they have a bigger machine to feed.

But should they continue to worry? The gloom mongers abound and the survey of future expectations shows a consensus that deal numbers will decrease and a resounding "Yes" in answer to the question "Should private equity fund managers sit on their hands rather than deploy capital?" The view is also that some businesses will need injections of capital and entry prices will fall, but is that all bad news for private equity?

Our answer is no. On the contrary, this will be a time of opportunity for those who can hold their nerve. Leverage may, as many predict, fall, but that is a good thing. Meanwhile private equity funds, which are long term by their very nature, often based on 10-year commitments (unlike their hedge fund cousins which can generally be called at short notice), still have the money to spend that they had before the slow-down started. Unless their suppliers of money, being pension funds and the like, begin to renege on their commitments - which, even in the current climate, seems a little surreal - they are well placed to profit from the bottom of the market: their money remains ready to spend.

Likewise, this is not a time for quick-witted entrepreneurs to retreat. Instead they should rejoice that some sanity is returning to financing structures and asset prices. Yes there may be a lull for a few months, but the private equity funders will soon be getting itchy to spend the money that is otherwise burning a hole in their pockets.

It will be fascinating to see what the current and subsequent quarter bring.

Jim Keeling, joint chairman, Corbett Keeling

www.corbettkeeling.com.

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