CLOUDS ON THE HORIZON

Could the European private equity boom be coming to an end?

Private equity people tend to be an optimistic bunch. That's just as well: in an industry where it takes years to establish whether an investment was successful, a fatalistic outlook wouldn't be particularly helpful. And so, when asked about their prospects in today's environment, industry types in Europe are likely to tell you that they expect to continue to fly into the wind in good spirit and with their heads held up high.

Except, some will add in a somewhat lower voice, that the head wind appears to be getting stronger. Private equity professionals, particularly those in fundraising mode, have no interest in calling the end of the boom that the European buyout industry has been experiencing over the past two years. But if anecdotal evidence is anything to go by, it's hard not to think that a majority of buyout professionals are quietly resolved to the fact that the times are about to get a fair bit tougher. And it's not just the prospect of rising interest rates that is causing concern in private equity circles. Pressure appears to be mounting on a number of fronts.

For a start, buying well – i.e. cheap – is becoming increasingly difficult across the entire deal spectrum. This is only partly because competition for assets between financial buyers is becoming more intense. It is also because other types of non-strategic investors, notably hedge funds, have been getting in on the act. In addition, cash-rich trade buyers have been dusting off their How to Make Strategic Acquisitions manuals as well. If, finally, you factor in that under-funded pension schemes are spoiling otherwise perfectly desirable acquisition targets, it becomes a safe bet that finding good businesses at appropriate valuations won't be getting any easier going forward.

Note also that according to market participants, vendors are growing increasingly nervous about selling to financial sponsors. In London for example, the word on the street is that billionaire entrepreneur Philip Green failed in his spectacular attempt to buy Marks & Spencer's last year mainly because the ailing UK retailer's shareholders just couldn't bear the thought of a (quasi-)private equity buyer making a success of the deal. The anxiety that a thrusting acquirer could reshape a super size company and in so doing make millions was a key reason that cemented the City's resolve to reject Green's overtures. The point of the story here? Mainstream institutional investors in public equities are developing a deep-seated suspicion of financial buyers who arrive at the scene of a corporate crash and bundle the candidate into an ambulance only to turn it back out onto the market at a huge premium soon after.

What's more, growing investor resistance is just one of the obstacles currently blocking private equity's path. Policy-makers also seem on a collision course. The UK tax authorities' decision in March to kill off an important tax benefit for private equity-backed portfolio companies was considered an openly hostile act by industry lobbyists who have since warned that more of the same, in Britain and in Continental Europe, could be on its way.

Losing the support of the policymakers is one thing; losing the support of lenders is another. Almost unprecedented liquidity in the capital markets has been a key driver behind private equity's rise to the top of the M&A tables over the past 24 months. But when debt to earnings multiples went from sixes to sevens, predictions that the leveraged finance boom was about to run out of steam weren't far behind. And you don't have to be a financial historian to find the suggestion that the current credit market is moving past a cyclical peak wholly plausible.

Following all of these developments with a growing sense of excitement are certain members of the media. I can think of a number of ([A-z]+)-based journalists who are waiting for an opportunity to stick their pens into an industry of which they have long been distrustful. The moment an aggressively leveraged, high-profile private equity portfolio company goes to the wall, these writers will be rolling up their sleeves. The resulting coverage will do little to improve private equity's standing with business owners, regulators, politicians, pension fund trustees and even capital markets professionals.

Looked at in isolation, none of these factors might be considered serious enough to cause a crisis. It's the prospect of simultaneous trouble on more than just one front that is causing buyout professionals to take nothing for granted at this point. By no means do the challenges ahead look insurmountable. And, as ever, an optimistic outlook will stand private equity in good stead. Just don't make it a blind optimism.