Why are private equity investors sniffing around the Lehman Bros. deal? The unlikely match is because private equity funds currently have all the money. Year over year for the last three years private equity has had record breaking capital raises. This is not just a domestic phenomenon, but a global one. Private equity has become a main stay investment vehicle in the global marketplace. Helped out by extremely large Sovereign wealth funds raising astronomical amounts of capital, private equity is flush with capital.
Sovereign wealth funds are, in essence, huge pools of private equity and they have already invested into some of the beleaguered financial companies such as Citi Group and Merrill Lynch. The reason? Private equity funds are having a very hard time finding companies to invest in or buy because the amount of competition for coveted mid-market companies has escalated the pricing on these companies. So, private equity funds are looking at alternate strategies to garner returns for their investors.
One such strategy is distressed investing in both equity and debt, similar to the Citi Group investment or the Washington Mutual investment by TPG Capital. The problem with distressed investing is that typically companies can become substantially more distressed and that risk needs to be gauged almost on a worst case scenario.
Could PE Funds be the saving grace for over leveraged financial institutions be they banks, investment banks or quasi government backed institutions? The answer is probably yes but PE Funds are not the risk takers of the hedge fund or venture capital community. They dig deep into these companies and look at what catalyst(s), other than time, will cause their respective investments to gain in value. It’s a good thing that PE Funds have long time horizons for realization of value.
The value proposition reminds me of the Bank of America debacle back after the crash of 1987 and then again in October of 1990 during the S&L implosion. BofA was in dire straits and looking like it was heading for bankruptcy or worse an FDIC bailout. BofA’s stock price had touched $6 per share and at that time it was literally one of the world’s largest banks. They managed to cut deals, reduce costs and receive some equity infusions from strategic capital and their stock price obviously recovered extremely well. At the time it was very hard to see anything positive about BofA or the stock markets, very similar to what we have today. Through this period of uncertainty and panic the market will present patient capital the opportunity to make significant capital gains.
Even if the Lehman Brothers deal doesn’t go through the opportunities for private equity funds in the financial sector will continue to rise. The larger deals are, of course, going to get a first pass with the bigger PE players like Carlyle, Blackstone, TPG and the Sovereign wealth funds, but there will also be a very large opportunity within the smaller, financial sector companies.
Another major potential for added liquidity in these US financial institutions could come from overseas banks that had a much lower exposure to the collateralized debt obligation (CDO) market. With a continued strong European currency and a number large banks and financial institutions looking for a deal this could be a real hotbed of M&A activity.
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