Private Equity is a big force in the investment scene. There are nearly 4,000 of these firms in the US, and they’ve invested in about 13,000 companies. They’re considered the “smart money” because of their acumen, insider knowledge, and ability to time the markets, which they have to in order to profitably exit their long-term illiquid investments.
OK, even the smartest among them got caught with their pants down last year when the oil price crashed. And those that invested in natural gas drillers have been regretting this move for years, after the natural gas price crashed in 2009 without ever really recovering since. Fracking, which boomed thanks to a near endless flood of money from Wall Street, including PE firms, has dished out costly lessons in return.
So, even the ultimate “smart money” can get carried away by its own hype. But recently, they’ve been doing something else: they’ve been dumping existing investments at record pace.
In the second quarter this year, exit volume by US-based PE firms “exploded” to $125 billion, according to a report by the Private Equity Growth Capital Council. This includes sales to the public via IPOs and to “strategic and financial investors,” such as corporations.
It brought the first-half exit volume to $195 billion, up 46% from the same period in 2014 and up a stunning 275% from the same period in 2013. Something is going on, and they want out.
And they’re not going to slow down anytime soon, “as corporate acquirers clamor for deals,” according to The Wall Street Journal:
On Monday, McGraw Hill Financial agreed to buy SNL Financial LC, the data provider backed by New Mountain Capital LLC, for $2.2 billion. That came on the heels of a $2.35 billion deal launched by WPX Energy Inc. for First Reserve-backed RKI Exploration & Production LLC.
They figured out, in an environment where nearly all assets are overpriced, it’s a great time to sell.
They already waited too long exiting their oil-and-gas investments, which now have started to collapse under the weight of debt and negative cash flows. Instead of struggling to salvage parts of their portfolio companies during restructuring or bankruptcy proceedings, they should have exited in 2013 and early 2014, when exuberance about oil covered up even the depression among natural gas drillers.
But elsewhere, things are still hopping. And it’s high time to get out before the energy debacle and the turmoil at the riskiest end of junk bonds spread more deeply into the PE firms’ portfolios.
And there have been eager buyers: the unsuspecting public via funds that invest in IPOs; and corporations that are buying everything in sight.
Corporations have been buying back their own shares. They’ve been buying privately held companies, including those dumped by PE firms. And they’ve been buying each other in the most awe-inspiring wave of merges and acquisitions the world has ever seen. The higher the price and the premium, the better. Corporations have become the relentless bid.
And they’re funding this binge with cheaply borrowed money. Junk bonds have seen rough waters recently, with investors getting re-spooked by the energy debacle, and issuance is down so far this year, compared to last year. But high-grade bonds are still booming though the first ripples have appeared.
US corporations issued a total of $802.9 billion in investment-grade bonds this year through July, according to Dealogic, up 27% from the same period in 2014. The most ever.
Of that, $701.7 billion were issued in the US, the highest ever, up 32% from the prior record set during the M&A bubble in 2007 (a now paltry $531.3 billion).
The average deal size jumped 33% from last year to $672 million, also the highest ever.
Yet, even in this rosy scenario, there were problems in July. For seven trading days early in the month, as the turmoil around China and Greece percolated through the markets and as commodities spiraled into a rout, no investment-grade bonds were issued at all. But then the floodgates opened. During the week ended July 17, a “blockbuster $46.9 billion” in investment-grade bonds were issued, according to S&P Capital IQ’s LCD.
In total, $130 billion in investment grade bonds were issued in July, despite the shuttered first week, the highest volume on record for a July, “dwarfing the $47 billion printed” in July 2014 and the $69 billion printed in July 2013. LCD:
July’s blockbuster issuance is owed predominantly to large M&A-driven deals. Earlier on in the month, Charter Communications printed a $15.5 billion bond offering in six parts, as it sought funds to complete its $80 billion acquisition of Time Warner Cable. This was the largest deal of the month.
During a year fueled by M&A action, the Charter bond issue ranked fourth in size, so far this year, behind Actavis ($21 billion in March), AT&T ($17.5 billion in April), and AbbVie ($16.7 billion in May).
Other mega bond deals hailed down in July: CVS Health placed a $15 billion offering to fund its acquisition of Omnicare and Target’s pharmacy businesses. UnitedHealth sold $10.5 billion in bonds for its purchase of Catamaran. Intel sold $7 billion in bonds for its acquisition of Altera. Etc. etc.
Corporations are buying everything in sight, offering huge premiums on top of the already insane valuations, and they relentlessly bid for their own shares, no matter what the price, and they do all this with cheaply borrowed money, even the smart money is dumping assets at record pace.
PE investments are largely illiquid. Exits take months and sometimes much longer to pull off. PE firms know that the window of opportunity will eventually close, and they can’t wait for the last minute.
Corporations are on the other side. Their angle is financial engineering and oligopoly building; to perfect this game, they’ve become the ultimate dumb money. But it doesn’t matter to their executives; they’re rewarded for financial engineering. And when the party is over, stockholders and bondholders pick up the tab.
But the acrid smell of burned fingers is wafting through the junk-bond market. Read… How Much Worse Can the Junk-Bond Sell-Off Get?
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