Reality of Private Equity Has Only Just Begun to Appear

By: Pete Kendall, April 2, 2008
The very latest headlines from the private equity sector mark the beginning of the end for private equity: ‘Dark Side to Leverage’ Slows Buyouts” (USAToday, June 28, 2007), “Market’s Jitters Stir Some Fears For Buyout Boom” (WSJ, June 28, 2007) and “Private Equity Faces Investor Revolt” (Financial Times, June 27, 2007).
The Elliott Wave Financial Forecast, July 2007


Here again, we were a little early. EWFF first discussed the private equity phenomenon in late 2006. But one of the things we stated was that the while private equity was the type of activity that tends to extend a long advance, it would be particularly onerous on companies that employ it. The reason is that it saddles firms with burdensome debts at a time when cash is getting extremely hard to come by.

“Instead of reducing their exposure to debt companies and individuals are increasing it,” said the December 2006 EWFF. “Buyers are financing the deals with private equity in which 70% of the purchase price is bank debt that is held on the balance sheet of the purchased company. According to Standard & Poor’s, corporations have also significantly increased their use of debt financing in acquisitions. ‘There has been a fundamental shift in companies’ attitude towards debt as shareholders have put more pressure on them to perform,’ says Standard & Poor. The more vulnerable the economy and markets get, the more precariously companies and individuals position themselves.”

So, a mountain of debt created by the upward surge of mergers and acquisitions (shown on the chart above) is not growing anymore, but it’s just starting to drag down many a balance sheet. The last chapter in the private equity sage will show the full extent of the burden created by these deals. It will become visible as deflation sets in and companies find it harder and harder to generate cash flow. In the end, there will probably be a very public back against private equity. This will appear as the economic contraction tightens its grip.