KUHN CAPITAL Monday, March 19, 2018
Dispatches from the front

Does This Hurt? How About This?

We sensed that the decline in PE firm deals had been severe, but now that weíve seen a Pitchbook Data report that quantifies things, we revise our opinion: Itís been more like a free-fall.

From investing $575 billion in 2007, PE firms spent only $43 billion in 2009, a 93% drop. Of course, 2007 was an all-time-high, eclipsing even the robust $318 billion invested in 2006. Still, 2009ís performance was nearly as anemic as that of 2002 ($36 billion) when the industry in its current configuration was still a baby. If you remember, in 2002, VCs and PE firms were still crawling out from under the wreckage of the dot.com bust. In retrospect, they were merely staggering from one boom-bust couplet into the next.

At least PE investment levels flat-lined in the last quarters of 2009 rather than continuing their precipitous declines. Maybe incremental improvements in credit availability and at least some stabilization in the condition of wounded portfolio companies explain the phenomenon.

Compared to the general 50% decline in number of PE deals closed, the IT sector continues to be a relative bright spot. Communications, networking, hardware, semiconductors, IT services and software deal counts only dropped 25% and the sector accounted for 14% of all PE deals done in 2009. IT has been an engine of M&A transactions for years now and yet fragmentation still invites more consolidation.

Another drag on PE firmsí investments has been their difficulty in finding exits for prior investments. Again, the comparison between 2007 and 2009 is dramatic: Last year saw 161 sales or IPOís while 2007 boasted 502. Itís tough to spend or raise money when you arenít making any.

Today, as before, strategic buyers represent the largest number of PE firm exit transactions, more than half the total. Because of their importance, when strategics bought 54% fewer companies in 2009, their inactivity accounted for nearly 75% of the total decline. Pitchbook believes this behavior was caused by pinched finances among the strategic set. We believe it was due to their hesitation to take on new risks in the face of an uncertain economic recovery and chronic political turbulence. Rather than finding themselves in financial straits, many operating companies tightened belts early and have been hoarding cash. We believe they will drive increasing PE sell-side transactions in 2010 assuming continuing economic stability and no major assaults on the free market by the current Administration. Of course, those two factors are big assumptions.

In sum, these are pretty miserable times for the PE business. Funds raised since 2005 generally show negative returns to date, with the degree of loss widening rapidly the more recent the fund. As weíve noted before, the usual way the market deals with this problem is by forcing players out of business, particularly the smaller ones.

Ryan Kuhn

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