The Future of Private Equity - MCK 2009
The Future of Private Equity - MCK 2009
Perspectives on
Corporate Finance
and Strategy
Number 31,
Spring 2009
11
Is there life after leverage for private equity? The global financial system is struggling to
work its way out of disaster: banks are flat on their backs, equity markets have plummeted,
and a business culture built on leveraged portfolios has come unhinged. The future of
private equity is one of the more intriguing questions for corporate finance and corporate
governance alike.
It may seem hard to be sanguine about
Yet the prognosis isnt entirely bleak. In
the sectors long-term prospects. With returns
our experience, the sectors strengths have
under pressure, private-equity firms
come not from its use of leverage but
will struggle to perform.1 The megabuyouts
from its ability to marshal resources, both
(deals valued at more than 5 billion)
human and financial; its strong incentives
that absorbed so much of the sectors capital to adapt quickly; and its active ownership.
since 2004 are nowhere to be found. Some
Opportunities do exist: megadeals may
limited partnersin particular, sovereignhave vanished, but not medium-sized or allwealth fundshave shown a willingness to
equity deals. Moreover, private-equity firms
bypass private-equity firms and strike out
are well poised to stand in as a new class of
on their own. With an estimated $470 billion
shareholder in the overturned publicin committed but unused funds, the sector
equity market, in developing economies, and
faces an enormous challenge just finding
in financial institutions. Despite the current
ways to invest. Finally, its portfolio companies, difficulties, it bears remembering that the best
with their high debt levels, may become
private-equity firms have persistently
financially distressed and default in the event outperformed both their private-equity
of only small downturns in sales and
counterparts and the public-equity markets,
EBITDA.2 Recent bankruptcies of several
in good times and bad, over the past two
private equitybacked companies hint
decades. The winners will be firms with the
at how dark the future may be.
wits to adapt to a much harsher environment.
12
McKinsey on Finance
Spring 2009
13
Managing investors
14
McKinsey on Finance
Spring 2009
Developing markets
Companies in developing markets enjoy
favorable demographics and are opening
up to the global economy. Nonetheless,
immature regulatory and legal systems, along
with a lack of transparency, can bedevil
outside investors who lack connections to
the companies in which they invest.
Although those companies may have local
sources of new money, they often lack
the value-adding capital that experienced
private-equity firms can offer. In particular,
family-controlled companies that aim to excel
internationally see them as a way to
gain expertise previously available only from
multinationals. Private-equity firms can
deploy their managerial and sectoral knowhow to help such companies, family
owned or otherwise, and to provide close
local supervision on behalf of the firms
international investors. These companies are
a very important long-term outlet for
private-equity firms, though from 2003 to
2007 their investments outside Europe
and North America accounted for only
around 5 percent of their $630 billion of
invested equity.
Financial institutions
In the past, private-equity firms seldom
invested in financial institutions, like banks
and insurance companies, which are
already leveraged to very high levels set by
regulators, as the current banking crisis
has clearly demonstrated. Yet today such
institutions provide a fascinating opportunity: they may be cheap, their productivity
varies widely, and recent events show that
they clearly need more intense governance
and will face demands that they obtain it.
The board of an average bank, for example,
could add considerable value by resolving
to use a private equitylike approach
to improve the banks operational and riskmanagement practices. Measuring the
value of so-called toxic assets presents real
15
that private equity has persistent outperformers and underperformers has been
analytically substantiated and taken root.
We therefore expect that the more discriminating limited partners will concentrate European and US investments in
fewer private-equity firms and that many
firms will disappear when they cant
raise their next round of funds.9
The alternative
If the private-equity sector cant identify
new channels for investment, it may have to
contract. In any event, it will probably
concentrate. The top ten firms controlled
30 percent of the sectors capital in 2008,
just as they did in 1998. Since then, the idea
Conor Kehoe ([email protected]) is a partner in McKinseys London office, and Robert Palter
([email protected]) is a partner in the Toronto office. Copyright 2009 McKinsey & Company.
All rights reserved.