When I read about 5 or 6 large buy-out funds bidding on a mature company in a mature market at 10x EBITDA valuations, I wonder where real value creation may come from.
In addition, the financial sponsor will have to add management layers that were probably unnecessary before and will have no access to synergies that an industrial player enjoys.
Truth is that the math of a traditional leveraged buy-out with no revenue growth, no EBITDA growth and no multiple expansion with a 50%/50% equity/debt capital structure is extremely hard, even with 6x EV/EBITDA valuations. Feel free to play around with my stripped down version of an LBO model spreadsheet on Google Docs.
Bloomberg News has an excellent round-up of recent figures of the private equity space: ‘Golden Era’ May Elude Private-Equity Investors as Prices Rise.
Private equity firms (especially the “mega funds” of $5 billion and above) have now significant amounts of money to invest, as in half a trillion dollar. These funds come with a “due date” on them: most funds were raised in 2005-2008 with an investment period of 4-5 years, meaning that this dry powder is going to “expire” in 2010-2012. Only invested funds will earn a 2% management fee when the investment period ends, which creates a perverse incentive to invest at any cost.
Finally there is a major supply and demand imbalance that is building up: when the time will come to realize these investments (made when funds needed to invest a lot of money) in 4-5 years, there won’t be as much “dry powder” floating around, given a 70% plunge in private equity fundraising that is now back at “new normal” levels of 2004.
As unlikely as it may seem, there is still a massive slack in the private equity industry (again, especially in the large LBO market) that will take another 4-5 years to work out.
