We believe that listed global private equity is an attractive component in a diversified portfolio. While the author of the following article agrees with our position, we believe that selecting high quality, active managers is a more appropriate approach than picking a couple stocks.
Private Equity Is So Damaged, It Looks Good
By Tim Melvin
8/25/2008 12:59 PM EDT
URL: Private Equity Is So Damaged, It Looks Good - Article Link
As I do every week, I sat down yesterday afternoon to peruse industry groups to see if I could spot key patterns or trends that might help identify long-term investment opportunities.
One group has just about everything going wrong. Revenue and earnings have been devastated. Book values have declined in the past year. Dividend cuts are not just likely, they are a near certainty. The group is heavily dependent on access to capital, and the financing environment is terrible. Naturally, all of this makes me think it is one of the best places to start building an investment position.
Private-equity firms have taken it on the chin in the last year, and many of the smaller firms were knocked right out of existence. But the survivors are going to be well positioned to buy assets cheaper than they have been in years, if not decades, as the credit and real estate problems begin to abate over the next year. It won't be just investors in the funds that will benefit. Shareholders in the handful of private-equity firms that are publicly traded should thrive as well if they have a long enough time frame.
Changes are occurring in private equity as well. More and more capital is flowing out of the U.S. to Europe and Asia. More than 50% of new private-equity investments in 2008 have been outside our borders. That ratio is expected to continue to trend toward foreign investments for U.S.-based firms. Growth rates in Europe and Asia are higher than domestic growth rates, and financing is more readily available for larger deals.
Private-equity firms are also starting to look into distressed investments as well. Many of the firms still have billions of dollars left unspent from the capital raising bonanza of 2005 to 2007 and are looking for alternatives to the leveraged buyout market. Leveraged buyouts are fairly nonexistent right now, and distressed equity and debt instruments offer an attractive place to invest excess capital.
In addition to corporate securities that are in distress, some firms have been buying leveraged loans and distressed mortgage portfolios from banks that need to clean up their balance sheets. They are buying them for literally pennies on the dollar, betting that they will work out to far more than that over the next few years.
Private-equity firms have a huge advantage in this market over typical hedge fund and investment firms. They have long-term locked capital in their funds and do not report results to investors on a monthly or even quarterly basis. They are uniquely positioned to handle the volatility that comes with a long-term commitment to troubled asset classes.
Investors don't have a lot of choices in this group right now. A few private-equity firms went public before the boom went bust. A few are still worth your consideration as long-term core holdings. The obvious choice is Blackstone Group (BX) . It is one of the largest private-equity firms in the world.
The firm went public in 2007, and shares reached an all time high of $38 a share. Today, they trade for less than half that amount. A combination of slower deal flow and almost nonexistent incentive fees has caused earnings to fall sharply this year. The firm is, however, well positioned for the current market. Blackstone is well capitalized and should be able to take advantage of weak asset pricing in the current stock and real estate markets.
It is also positioned in the right markets going forward. It just finished raising the largest-ever real estate fund to take advantage of falling property values. Blackstone is also making investments in Asia markets, infrastructure companies and clean energy. I would be a buyer of Blackstone shares here. I would buy some here and look to increase my position at every inevitable bump in the road.
Apollo Investment (AINV) is another firm active in private-equity market that is worth consideration for the long haul. The company is well positioned in the marketplace and extremely well capitalized. Its current investment portfolio is holding up well in spite of the economy.
It did raise capital earlier this year, selling over $380 million in stock to support its balance sheet and take advantage of opportunities in the marketplace. It is looking to be a major player in LBO loans and has already purchased several large loans at a discount, including those of First Data and TXU, two of the larger takeovers in recent years.
Apollo has set up a special fund, AIC Credit Opportunities, specifically to take advantage of the LBO loan marketplace. It may have to cut the dividend at some point in the near future, but that is not a significant consideration to long-term investors. In fact, I would use any weakness associated with a dividend cut to add to positions.
Private-equity investing may be a bumpy road in the near term, but the long term has extraordinary potential for patient investors who are willing to ride out the rough part of the economic and investing cycle.
At the time of publication, Melvin had no positions in stocks mentioned, although positions may change at any time.
Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.