Panel: Clock is ticking on equity deployment

As firms slowly emerge from the market downturn with their portfolios strengthened and their debt loads pushed back, deal flow is likely to grow as firms look to deploy the remaining capital committed to them, panelists said at a conference in New York last week.

Private equity firms have spent much of 2009 tending to their portfolios and defending their investments from the market storm. But the second half of the year has seen deal flow pick up and the debt markets open. Many firms are now in the position to find deals to spend the enormous amounts of LP commitments they have held in their coffers through the downturn.

“There’s so much liquidity on the sidelines,” Ken Hanau, managing partner with 3i US, said.

Some examples include Blackstone, which boasts about $13 billion in dry powder, Kohlberg Kravis Roberts, which has more than $15 billion, Sun Capital Partners, sitting on more than $4 billion and Trilantic Capital Partners, a firm that spun out of Lehman Brothers’ merchant banking private equity funds, which has about $1.7 billion.

Firms will need to find deals or be forced to return capital commitments at the end of investment periods, because many of them have yet to deploy equity committed to them in 2007 and 2008, said Philip Canfield, principal with GTCR Golder Rauner.

LPs would like to see deals getting done, but want to make sure GPs are not simply trying to deploy capital, but are being patient and cautious with the deals they choose, according to Kenn Lee, senior vice president with PCG Asset Management, a fund of funds. “A lot of firms we invest with, their pipelines are filling up,” Lee said.

Many deals today require bigger equity commitments on the part of private equity firms than in the past, and lending is still hard to come by. But the gap in lending will inevitably be filled by other companies, Hanau said.

“We shouldn’t be concerned with the lack of debt. The money will flow,” Hanau said. “We’ll see a plethora of new names … there are plenty of banks, private equity funds and hedge funds that will get into the credit side.”

Smaller banks who “did not get hammered” in the credit crisis will move into the lending gap and find attractive opportunities to finance deals, according to Randy Schwimmer said, senior managing director with Churchill Financial. “They’ll do a little riskier deals,” he said.

One area where firms have been exploring opportunities is building products, according to Steve Deedy, managing director with AlixPartners.

“Building products was hit hard, but you can find something cheap, and we’ve seen a lot of bidders in deals on companies that have survived the last couple years,” Deedy said. “We’ve seen a lot of money chasing deals.”

Another attractive area for private equity is healthcare, though the future of the sector is uncertain because of a national healthcare proposal from President Barack Obama being debated in Congress, panelists said.

The flood of private equity company defaults predicted by many industry experts in the next few years may not be as bad as anticipated, as more firms have found the markets open to refinancings, pushing debt maturities back.

“People love to have these looming things. The whole purpose of corporate finance is to kick the can down the road,” Schwimmer. “These refinancings will get done.”

Schwimmer gave an example of another doomsday prediction that has not come to pass. When two Bear Stearns hedge funds heavily invested in mortgage-backed securities collapsed in the summer of 2007, the market for collateralised loan obligations seized, leaving a jammed pipeline of loans worth about $280 billion.

“The $280 billion got absorbed, or the banks held them and dribbled them out, or deals got extended,” Schwimmer said. “There’s essentially zero pipeline from those days.”

Still, some firms will not be able to survive the next few years, and the industry will shrink, Canfield said.

“A lot of the committed capital will be put to work, and we’ll get to 2012 and 2013 and figure out who the Forstmann’s and Hicks’ are in this era,” Canfield said, referring to two major private equity firms that did not survive the prior downturn intact. “And there will be some, and the industry will be a lot smaller than it is.”