The industry uses borrowed money to make leveraged buyouts of companies, improves their operations and sells them back to public investors at a profit. Private-equity firms are facing the gravest crisis in their 40-year history after the credit bubble they helped inflate burst.
Unfortunately Bloomberg isn't specific on how PE firms will be economically annihilated. Here's a little exposition. A bear market for equities means there are very few exit opportunities for restructured private firms, so PE partnerships have to fund debt repayments from limited cash flows instead of with a huge lump from an IPO. The share prices of publicly-traded PE firms like Blackstone and Apollo have seen massive haircuts since their peaks in mid-to-late 2007. The principals of some well-known PE firms can see the handwriting on the wall:
At least two private equity veterans at the World Economic Forum, Joseph L. Rice III of Clayton Dubilier & Rice and David M. Rubenstein of Carlyle Group, said at the time that the era of giant leveraged buyouts was over, at least for the moment — and indeed, buyout deals topping the $1 billion mark were extremely rare in 2008.
A lot of "highly talented" people in PE firms that didn't want to look at my resume are going to be unemployed soon. The coming PE bloodbath will also change the politics of your financial advisor's branch office. It knocks one more leg out from under wealth management firms' fixation on "alternative investments," all highly-leveraged versions of a black-boxed promise to outperform good old-fashioned buy and hold investing. Remember hedge funds? They were supposed to provide absolute returns and "portable alpha" through thick and thin until they imploded from one-sided bets or Madoff-style Ponzi fraud. Don't worry, your broker will find something else to push on you in a bear market. Watch out for anything charging a premium for a low "downside capture" ratio.
Private equity as a prepackaged product for the HNW brokerage channel will disappear, but private equity as an investment style will always be around in some form. It will simply revert to its roots in limited partnerships that execute small and mid-sized turnarounds in local markets. Just pick your partners carefully. I certainly will.
Nota bene: Anthony J. Alfidi has no holdings in BX, AINV, or any private equity fund at this time. He is of course actively looking for private equity exposure. General partners are welcome to contact him. Carlyle Group, this means you, because defense technologies are well understood at Alfidi Capital.
