Size matters

FINANCE & ECONOMICS

Private equity

Jan 27th 2005
From The Economist print edition

Buy-outs are all the rage

RECENTLY, private-equity funds have been doing a record volume of business. Perhaps that explains why rumours that Goldman Sachs was poised to launch a $7 billion fund made headlines this week (the bank refused to confirm or deny the report). Such a fund would be the biggest run by an investment bank, and one of the biggest of all. Whether or not it goes ahead, the recent growth in the number and size of investments by private-equity firms shows that, for now at least, there is still plenty of appetite for their services.

Last year, according to Dealogic, a research firm, private-equity funds worldwide invested $302 billion, up by two-thirds from 2003 (see chart). America saw the fastest rise, with the total value of deals more than doubling, from $53.5 billion in 2003 to $127.8 billion. European investments grew by 37%, even though the number of deals rose only slightly. In Japan, however, private-equity activity fell by more than half, to $3.3 billion.

Not only is there more money sloshing around, but also deals of over $1 billion are becoming commonplace. The number of transactions of this magnitude soared to 79 in 2004, up from 42 in 2003. Last year's biggest deals included the $4 billion purchase by Kohlberg Kravis Roberts of PanAmSat, a satellite company. Intelsat, another satellite company, was bought for $5.1 billion by a group of private-equity firms including Apax, Permira and Apollo. This year's first big deal, a $5.7 billion offer by BC Partners and Cinven for Amadeus, a travel-reservations company, trumps any in 2004. Although private-equity firms are increasingly working together, there are clearly some benefits to scale.

The private-equity industry is usually seen as including two related businesses. One, buy-outs, involves acquiring established companies, often by taking them off the stockmarket. The other, venture capital, involves the funding of small firms, typically in technology or other fast-growing industries. In the past, small buy-out funds performed better than larger ones, but that has recently changed. According to Thomson Venture Economics, small buy-out funds (up to $250m) reported returns of 14.7% in the year to June 2004, compared with 26.3% for funds of greater than $1 billion.

Venture capital funds have been suffering, with a negative return of 12.2% on average in the past three years. Some are only now rebounding from the bust of 2001 and 2002. One firm, Apax, recently said that it would reduce its focus on venture capital and would pursue only later-stage deals. In future, seed funding for technology firms is likely to come from “angel investors”, typically rich people looking for diversification, rather than institutions.

Investment bankers have seen an increasing share of their fees come from private-equity deals. These have accounted for 14% of the value of global mergers and acquisitions in 2004, up from 12.7% in 2003, reckons Dealogic. That is one reason why Goldman Sachs, or any other bank, might think twice before launching private-equity funds that compete against their clients. Another is that, for all their contacts, investment banks' private-equity units have not always been as sharp as the independent shops. To take but one example: J.P. Morgan's outfit bet big on technology during the bubble—and lost a bundle.

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