There's every sign that 2014 will be the year private equity deals come roaring back, led by more huge transactions that recall the mega-acquisitions of the pre-crisis era.
Last year was the biggest for private-equity-backed buyouts since the financial crisis, with $274-billion (U.S.) worth of deals.
While that's a big number, it's still less than half the volume of the peak year, 2007, when $661-billion of deals were unveiled, according to tracking firm Preqin. Private equity transactions also remain a smaller percentage of overall deals, compared with the euphoria of seven years ago (which, you may remember, fuelled a bidding war for BCE Inc.).
But there are two big reasons to believe that much more buyout activity is to come.
Some of the more successful post-crisis buyouts are about to be sold, such as Canada Pension Plan Investment Board and TPG Capital's purchase of IMS Health, a health care technology company. The industry and its backers will feed the confidence bred by more headlines about private equity wins, which have been a bit scarce after some of the more inflated acquisitions of 2006 and 2007 that didn't pan out.
That's the psychology. There's also the math.
Fundraising for private equity firms jumped 13 per cent last year to $431-billion. Double that, to account for borrowing used in buyouts, and that's enough to fund almost a trillion dollars of buyouts globally. Of course, not all of that will come immediately in 2014, but firms are not raising money to sit on it. Bankers and bond markets remain open for lending on extremely favourable terms.
Besides, there will be more money coming in. Preqin researcher Ignatius Fogarty says 2,000 funds are on the road right now, seeking about $750-billion more from investors to use in buyouts.
What is really likely to drive a burst in deal size is the fact that the money is generally flowing into the hands of the biggest private equity fund managers, who run giant pools of capital. For the managers running a fund such as Carlyle Partners VI, which raised $13-billion, or CVC European Partners XI, which raised $14-billion, there is not much point in doing small transactions.
Canada is likely to see plenty of this activity. The country's private equity firms set a record for the amount of money committed by investors last year, according to Reuters PE Hub, with about $16-billion in funds raised by private equity and venture capital firms. Onex Corp., Canada's largest private equity firm, is in the middle of raising its latest fund. Investor surveys have shown that PE firms prefer the developed countries at the moment, and are less keen on emerging markets.
The real question is whether private equity firms have learned from their mistakes, which led many of the deals from the boom to be busts. For example, the utility Energy Future Holdings, the biggest company bought out in the last wave, is in trouble. There is speculation the company, once known as TXU Corp., will be forced to file for protection from creditors in the coming year. That would be a $45-billion black eye for the companies that bought it: TPG, KKR & Co. and Goldman Sachs Group Inc.
So far, buyout funds seem to be showing more discipline in this cycle, especially in the use of debt. Even though bankers are willing to finance, sponsors are being careful. After leverage jumped in 2012, firms dialled back the amount of debt they were using in buybacks, keeping the prices paid in check. According to tracking firm PitchBook, median debt has been tracking in the 50-per-cent range in 2013, meaning deals are roughly half debt and half equity, compared with at least 60 per cent in every year from 2004 to 2008.
That discipline is going to be tougher to maintain. There will be so much more money chasing deals, not only from the private equity business, but from cash-rich companies that would like to do more strategic acquisitions.
The unfortunate side effect will be that the biggest private equity deals of 2014 may resemble the boom years not only in size, but performance.