2008 predictions

This year has been the most high profile in the history of private equity. The UK industry has been the focus of many headlines, from the long-running Sainsbury's saga, to the Walker Report and the Treasury committee hearings. Globally, the industry has attracted more attention than ever. The flotation of The Blackstone Group and the subsequent acquisition of a 9.9% stake by an arm of the Chinese Government, revealed the changing nature not only of the private equity industry, but also of capital flows across the globe. Record-breaking deals and fund sizes ensured the industry was never far from the main story on the business pages and occasionally saw its way onto the front page. In the UK and the US, the question of taxation of carried interest raised the profile of the industry further, as has the 2008 US presidential election and campaign donations by private equity executives. Now, as 2007 draws to a close, thoughts are already turning to 2008. Here, we get the forecasts for private equity in 2008 from a range of industry players.

Andrew Hartley, August Equity

On the credit crunch

"The liquidity issue stabilised after a couple of weeks in our space. The price of debt is up a few basis points on the margins and we are seeing slightly tighter terms. There will be some downward pressure on prices going forward, but deals are still getting done on a single bank basis."

On UK capital gains changes

"It was a bizarre move with no consultation. The sensible thing would have been to lengthen the taper relief period. This change will take us back to the bad old days of arbitraging capital and income."

Nathalie Faure-Beaulieu, European Capital

On syndicating debt

"Investment banks will find it difficult to syndicate B and C debt tranches because the market cannot price the risk. Therefore, investment banks in particular are reluctant to underwrite deals, especially at the top end. With the CLO market shut and banks unlikely to reopen warehousing facilities, liquidity is not going to return any time soon."

On mezzanine

"With spreads increasing, the credit squeeze presents a great opportunity for mezzanine lenders."

Jon Breach, BDO Stoy Hayward

On UK capital gains changes

"Where private equity funds are into the territory of paying out the fund's carry, there is a strong incentive to realise the remainder of the investments in these funds. We will see a rush of exits in the small, mid- and large buyout market before the higher rate of capital gains tax kicks in on 5 April [2008]."

On trade buyers

"Trade buyers will be very active over the next six months, especially where they are sitting on cash or are under-leveraged perhaps picking up some of the companies that private equity houses are looking to exit ahead of the April CGT deadline."

Guido Justen, Helaba Bank

On returns

"We will see less draw-down in capital and fewer deals in the short term, as well as less distributions, but this will be a three- to five-year trend. In addition, IRRs will return to the low 20s from the mid- to upper 30s we have been seeing in some funds over recent years."

Thierry Baudon, Mid Europa Partners

On liquidity in CEE

"Contraction of the debt markets is unlikely to affect dealflow in any material way, as Central Europe continues to enjoy strong GDP growth and offers significant cross-border M&A opportunities. The picture may differ from country to country and sector to sector, but overall, 2008 prospects are very good."

Tom Lamb, Barclays Private Equity

On defaults

"Defaults could become an issue for companies that had planned a refinancing in 2007 and did not achieve one, or which have been refinanced on stricter terms. In this case, capital repayments could place extra pressure on the business, which may trigger covenants or lead to a default."

On sovereign wealth funds

"Sovereign wealth funds will find it difficult to do direct deals as they do not have the in-house knowledge or access to dealflow that a private equity firm relies on."

John Gripton, Capital Dynamics

On Q1 activity

"Q1 2008 activity will be slow, especially in the large-cap space, as legacy debt is sold down and managers assess the impact of lower leverage financial models and find other ways to generate value."

On fundraising

"Many funds have invested rapidly in recent years to take advantage of favourable market conditions. There will now be a pause for thought. This should allow the fundraising cycle to revert to an average of three years, providing better time diversification for underlying company investments."

Javier Loizaga, Mercapital

On Spain

"In Spain, we are not facing a recession, but we will experience a significant economic slowdown in 2008 and this adds to the current market ambiguity. Sellers are not yet adapting to the new pricing reality, while European private equity managers have not ceased to fund raise. If the tightening in the markets lasts much longer, it is possible that we will see firms with a large capital overhang."

Caroline Grounds, UK head of private equity at Ernst & Young, assesses the prospects for private equity in 2008

"Following turmoil in the credit markets, the major banks have written off an aggregate of $30bn on sub-prime exposures (so far). While the default rate for large leveraged buyouts has not changed, these sub-prime exposures arrived at the point where there was a backlog of approx $350bn of debt awaiting syndication on closed deals. In the absence of normal credit markets, this 'overhang' is taking some time to refinance.

"Despite all this, the private equity market, year to date, is still 32% ahead of last year. At the core, the underlying fundamentals for the industry remain rock solid. Research performed by Ernst & Young shows that the enterprise value (EV) growth of private equity owned businesses outperformed the like-for-like EV growth of public sector businesses by 800 basis points. EBITDA growth was 300 basis points ahead and headcount growth was 200 basis points ahead. On this basis, pension funds will continue to direct more of their funds towards private equity and, indeed, fund raising continues without a pause for breath.

"At the large leveraged buyouts end of the market, the M&A 'pause' will continue at least until the New Year across Europe and the US and, in reality probably until Q2. Reinvigorating the deal pipeline will take a bit of time and that could stretch the timeline for getting the market back to normal.

"Unconnected to private equity, credit losses and falling house prices could have an impact on the US economy that sends a shudder through European consumer confidence and delays the M&A market pick up further. The EY Item Club has trimmed its UK growth forecasts from 3.1% to 2.1% in 2008, due in part to the credit crunch.

"However, there will be plenty of deals. Many large deals have been delayed, but there are still a few quality deals (with financing) in progress or in the pipeline across UK and continental Europe. There are some very large deals waiting in the mining and telco sectors. Private equity deal activity in the mid-market and 'new' Europe continues at a clip with stable funding. But, everywhere we can see a return to old fashioned credit assessments, conservative structures and covenants.

"Finally, the sovereign wealth funds, India and Russia have plenty of money, need less debt and have not heard of the credit crunch!"

Armando D'Amico at Acanthus Advisers gives his predictions for private equity in 2008, focusing on three main areas

Fundraising: "As a consequence of the credit crunch we have already seen a slow down in investment and exit pace. We therefore expect a lengthening of fundraising cycles with funds coming back to market at a more normal rate as opposed to, in the words of one LP, "a mad rush to close funds when conditions were easy". Mega funds will feel this impact the most, while, according to our research, we expect mid-market fundraising to remain robust, with only a marginal decline. The spotlight will be on markets where private equity is riding changes in the fundamentals, for example in Eastern Europe, where fundraising has doubled in each of the last two years, with some EUR4.5bn expected in 2007."

LP appetite: "We have identified two trends we expect to continue. One is the increasing demand for the European mid-market (funds of EUR100m to EUR1bn in size): we continue to see more LPs with mandates targeting this segment, and in 2007 have tracked record numbers of US LPs opening offices in Europe or appointing advisers with more focused mandates. The other clear trend is an increasing appetite for special situations funds - we expect this market to expand and more LPs to commit to it."

Alignment of interests between LPs and GPs: "This issue has taken centre stage in recent years. Our 2007 Survey of LP/GP relations indicated that both parties overestimated the quality of their communications and highlighted fund terms as the biggest area of friction, as the abundance of capital encouraged some GPs to be less concerned with maintaining good relationships with their LPs. As one LP put it: "the overheated fundraising cycle is allowing funds to relax on transparency and corporate governance". However, what goes around comes around. We expect some of the power to shift back towards LPs after the warning shot of the credit market turmoil."

"So what will 2008 bring? As these trends unfold we will begin to see the answers but, in the main, at Acanthus we expect a more challenging fundraising environment - not because LP appetite for private equity will decline, but because LPs will be more selective. After all, the private equity firms capable of outperforming will always be a scarce resource."

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