Survival of the fittest

01 October 2008

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From the rescue of HBOS by Lloyds TSB to the nationalisation of another British bank, not a week seems to pass without more evidence that the structure upon which the last decade of prosperity was built was over-optimistic and under-regulated. During the heady days of the cheap credit boom, fuelled by complex derivatives products and rampant securitisation, the belief arose that risk could effectively be eliminated. We are now witnessing the fall-out from this hubris, with the UK and the US at the coal-face. For the private equity industry, things are unlikely to ever look the same again

Just a few days ago MFI was sold back to its management team by Merchant Equity Partners (MEP), a rescue funded by a dowry provided by MEP. This came after landlords were warned they were unlikely to receive rental payments if a buyer could not be found. There are certain to be more private equity-backed businesses which face calling in administrators over the next few months as revenue falls and investors struggle to meet rent and debt payments. In this environment a strong management team with experience of difficult economic times is the most valuable asset a business can own. In addition, those private equity firms with a pool of high-quality non-execs they can tap, alongside in-house operational experience, will be best placed to withstand the recession.

The default response by private equity pros to questions about falling returns and distributions to LPs is that deals done in a downturn show the best return on exit. There is little doubt that this is the case and the closer an investor calls the bottom of the market the more profitable the ultimate outcome, but asset selection and the ability to effect change is crucial when investing in a downturn. Not all GPs have this ability; those that don't got away with it in the past few years by generating returns through leverage and riding the wave of multiple uplift. With credit scarce and multiples heading south, this is no time for the weak.

Yours sincerely,

Nathan Williams

Editor, unquote"

Tel: +44 20 7004 7449

nathan.williams@incisivemedia.com.