The private equity boom

Rozanna Wozniak, Chartered Accountants Journal, Volume 86 No. 2 March 2007

This article discusses the boom of private equity funds that arose out of the high level of takeover activity undertaken globally in 2006.  It considers what private equity funds are, the risks and international equities in 2007. 

The general conclusion reached by the author is that, although there is scope for further growth in global equity markets, it is expected to occur at a more modest pace than in 2006.  The article also concludes that the result of a reduction in takeover activity, and subsequently the decline in private equity funds, would result only in a period of disruption and volatility to investors, rather than cause a major disruption to global share markets. 

What are private equity funds?

Private equity funds obtain capital from investors, and combine this with new debt to undertake heavily leveraged buyouts, either on their own, or in partnership with other funds.

Where potential exists to enhance the efficiency of companies, both in terms of their operation and their financial structure, it is the future earnings potential that will determine the price that private equity funds are willing to pay to purchase a company. 

Often, private equity funds will target companies that are “cash-rich” on the basis of a belief that low gearing and ample cash is a sign that a company has under-invested. 

The risks

Investors are lured into private equity funds by high returns.  However, high returns come with high risks.

The rapid growth of private equity funds has resulted in larger, more expensive and more leveraged buyouts.  The focus has also shifted from private companies that need financing to fund growth or development towards larger publicly-listed companies.  The primary aim of private equity managers can also be said to have changed from a long-term aim to now seeking to transform their acquisition as quickly as possible so that it can be on-sold or re-floated at a higher price. 

These recent trends have raised concerns among regulators due to the risk of default of a private equity-backed company or a cluster of private equity-backed companies which would impact (at least over the short term) on the wider financial markets.  Although the disruption might not be serious or sustained, it would cause a period of increased volatility.

International equities in 2007

The author contends that, if recent levels of merger and acquisition activity are sustained this year, global equity markets will enjoy yet another year of strong gains. 

However, she also warns that, given recent trends in the private equity sector, there is an increasing need for a cautious approach by investors.  The large returns that many private equity funds have generated in recent years will be difficult to repeat and will have increased risks attached to them. 

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