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.
While the funds are unlikely to gobble up companies whole, it would still help buyout firms address the plunge in secondary deals — or private equity firms buying and selling to other firms.
“Sovereign wealth funds typically seek lower risk, lower returns,” which is why they may look more at secondary deals, he said.
Secondary buyouts often involve lower risk for the buyer because the previous private equity owner presumably made the company more efficient and profitable. That means a lower return for the next owner — which plays right into the strategy of sovereign funds.
“We’re not driven by artificially mandated liquidity events,” said Kenneth Shen, head of private equity strategy at the Qatar Investment Authority, speaking last week in Dubai of how sovereign funds have longer time horizons on investments and lower return expectations, relative to the expectations of buyout firms and hedge funds.
“Groups like ours are less leveraged than other institutional groups and less risky,” Shen said.
Smith, of UBS, thinks buyout firms will look to the IPO market before sovereign funds. Even some of the large leveraged buyouts in the tens of billions of dollars are not too large to hit public markets.
“I think there’s enough liquidity in those markets to handle that kind of size,” he said. “If it’s a premier asset and positioned correctly with global distribution — there’s a lot of money out there.”
Reporting by Michael Flaherty; Editing by Andre Grenon