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Industry Viewpoint - Fall 2009

What Next for Private Equity? - continued

THE PRIVATE EQUITY CEO

Ted Virtue

Six months ago, everyone in the private equity marketplace was expecting the next year or two to be one of the busiest and most attractive investment periods in our lifetimes. The financial market meltdown sparked by the Lehman bankruptcy last September left every company and bank scrambling for liquidity. The $400 billion of committed but undrawn private equity in funds looked like one of the few sources of long-term capital available outside of government intervention. Every company facing a covenant default or a maturing revolving credit, term loan or bond looked like it was going to either go bankrupt or need to turn to a private equity solution.

To the surprise of many, the credit markets have had an unprecedented rally, opening up the primary market for over $100 billion of new high-yield bonds and over $1 trillion of high-grade corporate debt issuance this year to address companies’ liquidity concerns. Even companies in the depressed airline, home building and retail sectors have had access to long-term debt. The equity markets have rallied over 50% from their lows, enabling companies to issue equity to delever and recapitalize. And banks have been more accommodating in providing waivers and amendments to defaulting debt, pushing leveraged capital structures forward.

With panic-selling pressure alleviated for the time being and only modest amounts of credit available for new deals, I believe private equity firms will still have two significant investment opportunities in this market environment. First is to equitize the many balance sheets that remain overleveraged from the easy money period of 2004-2007 so they can ride through the cycle. Many of these capital structures have extended their maturing debt but not deleveraged. This will be a big opportunity, especially in the absence of an economic recovery in the next 12-18 months.

The second opportunity is the need for traditional growth capital to transform companies and sectors. This has been a core strategy of private equity firms until easy money led firms to focus more on financial engineering than operating strategies. As companies move from survival mode to growth, private equity capital should be a needed source of funding for many companies and sectors to grow organically, consolidate within their industry and expand their geographic markets. Many of these deleveraging and growth investments will come in the form of minority investments, structured securities and PIPEs similar to the deals Leonard Green did for Whole Foods, BC Partners did for Office Depot, and KKR recently did for Kodak.

Ted Virtue is the CEO of MidOcean Partners.