For private equity, exits and sovereigns key in 2008

By Michael Flaherty

NEW YORK (Reuters) - With debt financing in the dumps and cash flow valuations still relatively high, private equity firms and their bankers are hoping that selling their companies can keep profits and fee streams flowing in 2008 should recession become a reality.

In addition, the large private equity firms that teamed up and bought and sold from each other for years are now looking for partners with even more cash -- sovereign wealth funds from the Middle East and Asia.

If buyout firms fail to sell assets and the economy slows even more, the private equity industry will face two problems: a worsening lending climate and depressed values for the companies they own.

While leveraged buyout firms are set up to buy companies on the cheap, a dearth of bank loans will make purchases harder and more expensive.

So with a new year just a few weeks away, executives at buyout firms are focusing less on major acquisitions and more on tuning up portfolios, prepared to hit the eject button on assets they bought when valuations were lower a few years ago.

"I think you're going to see a lot of activity in terms of portfolio monetization in 2008," said Steven Smith, head of financial sponsors and leveraged finance at UBS AG (UBSN.VX) in New York.

Among the larger companies purchased by private equity firms in 2004 that remain private are film producer and distributor Metro-Goldwyn-Mayer (bought for $4.75 billion), timber company Boise Cascade Corp ($3.72 billion) and media and marketing company Visant Corp ($2.2 billion).

Software company SunGard Data Systems ($11.76 billion), retailers Toys R Us ($8.17 billion) and Agilent Technologies ($2.66 billion), which makes electronic testing equipment, were some of the largest leveraged buyout targets in 2005. They also remain private.

Whether the private equity owners of these companies decide to keep or sell them next year remains to be seen.

Fee hungry Wall Street banks very much hope their buyout clients sell assets after the credit crunch brought the private equity Golden Era to a halt this Fall.

Although that may be wishful thinking, a few factors support the idea.

For one, the U.S. initial public offering market has remained robust even during the credit market turmoil, giving buyout firms more reason to offer their companies.

In addition, sovereign wealth funds from the Middle East and Asia have emerged as eager buyers of U.S. assets. The funds have purchased stakes in public companies and private investment firms at a record pace this year, seeking to diversify their holdings and boost investment returns.

The Abu Dhabi Investment Authority bought a $7.5 billion stake in U.S. bank Citigroup Inc (C.N), while one of Dubai's investment arms bought a piece of hedge fund Och Ziff Capital Management Group (OZM.N).

The funds may also be interested in buying stakes in private equity owned companies, according to John Coyle, head of the financial sponsors group at JPMorgan Chase & Co (JPM.N) in New York.