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The glory days of private equity and the storied leveraged buy-outs of public companies now seem like many light-years away. Leveraged bravado has given way to equity in regret. After we got our first sub-prime related market sell-off in February, 2007, I wrote a piece titled "Private Equity Prays the Hardest that the Market Has Not Topped Out." I made several claims then, some right, some wrong. For example, I declared that the stock market had indeed topped out, but it took three more false recovery rallies before we finally put in a top eight months later. (It never ceases to amaze me how poorly the stock market can perform as a pricing mechanism). But what brought me back to this old piece was a CNBC Fast Money segment last Thursday featuring legendary bear Doug Kass. In this segment, Kass warned that private equity is the next shoe to drop in our on-going financial troubles with contagion effects on college endowments and pension funds. I had been wondering whether my earlier suspicions about private equity had any validity.
Last year, I wrote (emphasis new):
"In the years since the collapse of 2000-2002, we have witnessed a set of rolling booms, some of which have already been ground back into the dust of bust. The celebrated largesse of private equity is certainly the latest of these booms. It seems as if we cannot go one week without the financial pages heralding the triumphant acquisition of another public company by private money. As we have noted many times, the world is awash in cheap and easy money, and these buy-outs are yet another manifestation of the boom in paper. But what is more interesting than the chase after public companies is who is chasing the private equity. The Wall Street Journal reports in "How Labor's Pension Funds Are Playing Private Equity Two Ways" (by Alan Murray) that public pension funds were the largest source of funds for private equity in 2005...22% of all newly raised money. Essentially, "public" funds are being used to convert public companies into private companies. Nice! To the extent that this boom is headed to some kind of bust, we can see the ripple effects could be wider than we might originally expect."
I highly recommend watching the Fast Money video and reading Kass's article (links above). One key quote: "Like post-2005 vintage mortgage lending, most private equity deals done over the last two and a half years (estimated at over $900 billion) are now worthless (as are some of the early vintages)."
Once the housing market set new lows in its throes late last year and then the stock market crumbled this year, I thought private equity would finally make good plays. My thinking was that private equity would refocus on the business of buying distressed companies at a DISCOUNT and find ways of turning disasters into profit. If this scenario does eventually play out, it seems it will happen only after we suffer through some more financial catastrophes.
Be careful out there!
Full disclosure: Long BX. For other disclaimers click here.