As if things weren’t bad enough already for private equity and hedge fund managers, it seems to be a pretty safe bet that their tax rate will be going up - though it may not make much difference to many of them until their returns go up too.
Deloitte provides a handy table of “Democratic revenue enhancement opportunities” in a useful summary and analysis of tax proposals. The report tabulates the proposals based on whether they are part of President-elect Barack Obama’s agenda, whether they are under active discussion by Congress and whether they are part of House Ways and Means Committee Chariman Rangel’s comprehensive tax reforms. Only one proposal has all three boxes checked; Taxing carried interest as ordinary income (as opposed to at the much lower capital gains rate). This proposal is targeted at managers of hedge funds, private equity and venture capital but would also affect general managers in a variety of business entities.
There are compelling arguments on both sides of the issue. Those supporting the new proposals argue that deferred compensation, even if risky, is still compensation. Or, as Paul Krugman has asked,
why does Henry Kravis pay a lower tax rate on his management fees than I pay on my book royalties?
Those who support the current system, including the current Bush Administration and the Private Equity Council, argue that treating carried interest as long-term capital gains are a way to reward entrepreneurial investment, likening investors in pooled assets to those who might launch a business.
Regardless of where you stand on the issue, the current economic and political climates suggest that a change is likely to come.
The free Deloitte report is worthwhile just for this one table of potential revenue opportunities, but includes analysis of many other aspects of tax policy, including this table of income tax rates:
Technorati Tags: carried-interest, Hedge-Funds, income taxes, private-equity, taxes
Merger and acquisition activity in the marketing, advertising and digital media industries proved surprisingly resilient during the first two months of the third quarter of 2008, but began to soften in September, according to investment bankers Petsky Prunier.
In its Third Quarter Deal Notes, Petsky Prunier tracked 168 transactions worth a total of $11.1 billion in estimated transaction dollar volume in 3Q08. While the total number of transactions was down 29% from 3Q07 and 12% from 2Q08, total transaction dollar volume was up 30% and 68%, respectively.
Similar to 3Q07 and for the second quarter in a row, the Digital Media segment generated the largest share of industry activity, with 66 transactions totaling $5.1 billion, followed by Information, which recorded six deals for a total of $3.3 billion.
Digital Media also led in total number of transactions announced with 66, down 20% from the same quarter last year, but up 74% from 2Q08.
Although Marketing Technology was 3Q08’s second most active in terms of deals announced, the numbers declined in the segment, with transaction volume down 27% from 2Q08 and dollar volume down for the third straight quarter.
Overall, strategic buyers generated the largest portion of total transaction value, with 80 deals worth $9.2 billion. In the first nine months of 2008, the 11 most active strategic acquirers announced 53 transactions. Venture capital companies completed 80 transactions during 3Q08 worth approximately $757 million. Private equity firms chose their targets carefully in 3Q08 and completed only eight buyouts, a reflection of the weak credit environment.
Technorati Tags: digital-business, marketing, Media, mergers and acquisitions, private-equity, venture-capital
While it may turn out that this is not something to be bragged about, most financial markets grew more rapidly in Europe than in the US, both in 2007 and over the last several years, according to International Financial Services London.
Key findings from IFSL’s annual report Financial Market Trends Europe vs.US 2008 show that in over half indicators - 10 out of 16 - financial markets in Europe grew more rapidly than the US in 2007. Over the longer period since 2001 activity in Europe rose relative to the US in 13 out of 18 markets.
Most of the gains over the past six years have been in 8 out of 9 sectors where activity in Europe is smaller than the US: these include hedge funds, securitisation and equity market turnover, IFSL said. Europe has also made some large relative gains since 2001 in sectors where it has the larger market, including IPOs, cross border bank lending, issuance of international bonds, and insurance premiums.
The US has made up ground in a few areas in recent years, particularly foreign equity trading, where the gap with Europe has been largely closed, as well as OTC derivatives where Europe’s lead has been curtailed.
The report is based on 2007 data when the credit crunch was in its early phase so does not take account of the deterioration in credit markets in 2008. Some indicators such as investment banking revenue, securitisation and IPOs are likely to fall in 2008, but it is not yet clear how this will influence the relative positions of the US and Europe in financial markets, IFSL said.
Technorati Tags: banking, derivatives, equities, financial-markets, financial-products, forex, Hedge-Funds, Insurance, private-equity
The private equity community does not appear to be overly panicked about the turmoil in public markets, according to a survey of attendees at thiis week’s Private Equity Analyst Conference.
Sponsor Dow Jones Venture Wire (subscription required) reports that attendees weighed on a variety of topics, including future return expectations from recent vintage years, the outlook for future deals and fund-raising, as well as when the credit crunch may lift. Perhaps reflecting the long-term outlook of the asset class, their answers indicated that while they expect current grim market conditions to last for some time, they do eventually see improvement.
“People are in a much calmer state of mind than the general public or Wall Street commentators,” said D. Malcolm Wright, a partner in the private equity group at KPMG who conducted the interactive survey.
Attendees remain relatively optimistic in their return expectations for U.S. private equity funds raised between 2005 and 2007, with 51% betting that although returns will not be great they will be okay. Another 25% felt that those years were a good time to invest in distressed debt and mezzanine but a bad time for large buyout funds.
Among the skeptics, 16% of the audience felt that many investors will wish that they had put their money under the mattress instead.
A slim 8% still view the 2005 to 2007 vintage years as a very good time to have invested.
On the deal side, 67% of attendees predicted that deal flow will remain patchy in 2009 as buyers and sellers grapple with the effects of the economy. However, 11% still feel that there will good quality deal flow in all sizes and sectors of the market, with another 15% predicting that there will be deals, but that they’ll be restricted to the mid-market and below. Only 7% said that the only area of private equity that will see good deal flow in 2009 is venture capital.
Technorati Tags: private-equity, venture-capital
The Economist has an interesting analysis of the prospects of private equity riding to the rescue of beleaguered financial institutions.
“Buy-out firms are unlikely saviours, but private equity’s $450 billion war chest is big enough to fill Western banks’ capital shortfall,” the magazine notes. “There are few other sources of ready capital. Sovereign-wealth funds have been badly burnt; banks cannot easily raise equity in public markets; and the atrophy in many of the biggest lenders leaves them in a poor state to buy the weakest.”
“On one side of the financial system are buy-out firms with ambition, long-term capital, discretion about how to invest it, and a dearth of opportunities to invest in industrial companies. On the other are banks, desperately short of capital and liquidity.”
It does not take a billionaire buy-out barbarian to put two and two together.
Most buy-out firms have started by buying the distressed loans that banks issued to fund LBOs, many of which trade at 70-80% of face value. Only a few big deals have been made public: Citigroup’s sale of $12 billion of debt to TPG, Blackstone and Apollo, for instance. But behind the scenes the activity has been frenzied.
One alternative to buying banks’ loans is to buy their holdings of the securities at the heart of the crisis—structured-credit products backed by mortgages. Blackstone is talking to “several institutions” about buying mortgages. Last month Merrill Lynch offloaded a pile of collateralised debt obligations at a knock-down price of $7 billion, or 22% of their face value, to Lone Star, a private-equity firm.
But Lone Star has a history of specialising in finance and such deals are unusual. When UBS auctioned a portfolio of securities backed by “Alt-A” mortgages in May, it received little interest from private-equity firms. This may be because these securities are highly technical. In addition, they are passive investments that do not call for the operational management where private equity thinks its skills lie.
For mainstream private-equity firms, the promising business may lie elsewhere: buying into banks themselves.
The Economist recognizes that “before private equity takes the plunge, the rules may need to be tweaked. As early as next month, the Fed is expected to offer more guidance on the grey area of the ownership thresholds, probably relaxing its stance.”
The Bank Holding Company Act, which governs most big deposit-taking institutions (although not broker-dealers), stipulates that a voting stake in a bank of 25% or above constitutes control, whereas a holding of less than 5% does not. “Between these two thresholds is a grey area that the Federal Reserve has interpreted conservatively, taking into account, for example, whether the owner can appoint directors or owns non-voting capital too.”
Technorati Tags: banking, private-equity
Companies with a board member who has prior LBO experience are much more likely to receive a private equity offer, according to a new working paper.* The paper examines the propensity for U.S. public companies to become targets for private equity-backed, take-private transactions.
Looking at 483 private equity-backed deals in the 2000-2007 period relative to public companies the paper finds that, in addition to the financial drivers studied in previous works, board characteristics and director networks are also associated with deal generation.
We find that a company that has a director who has had LBO experience through prior board service is ~40% more likely to receive a private equity offer and that the strength of this effect varies with the influence of the director and the quality of the prior LBO experience.
The paper’s findings support the idea that directors and social networks play an influential role in change-of-control transactions.
* Board Interlocks and the Propensity to be Targeted in Private Equity Transactions - by Toby Stuart and Soojin Yim.
Technorati Tags: LBO, private-equity, social-networks
US venture investing declined again in the second quarter and year-to-date numbers are off 8% for deals and 5% for dollars invested from the first half of 2007, according to the latest data from VentureSource.
Dow Jones VentureWire (subscription required) reports investors pumped $13.9 billion into 1,241 deals in the first half of this year.
How much the slow economy and absence of venture-backed initial public offerings had to do with the decline is unclear, however, because venture investors say their portfolio companies generally are in good shape and that the lack of liquidity, while worrisome, could be a short-term problem.
“What tends to slow people down is if their portfolio companies are really, really struggling,” said Battery Ventures General Partner Tom Crotty. The firm has just finished its first-half portfolio review. “I’ve been pleasantly surprised at the good execution of the portfolio against their revenue plans,” he said. “That keeps people in a reasonably bullish mindset.”
On the flip side of the equation, venture firms have plenty of capital to deploy.
Venture capital fund-raising in the first half was up 15%, to $11.5 billion, according to sister publication Private Equity Analyst. It’s also noteworthy that the number of active venture investors in the U.S. continues to decline as poor performers wind down. This could be having some effect on the deal pace.
The energy and utilities sector was one of the few bright spots in the first half, while information technology saw a significant drop and health care leveled off in the second quarter after a very poor first quarter.
Technorati Tags: private-equity, venture-capital
Privately-held businesses face the most demanding outlook in decades during the next 12 months, according to a new survey from Grant Thornton.
The firm’s International Business Report 2008 says US privately held businesses will need to make decisions to become increasingly competitive, whether the economy continues on its downward slope or not.
“The weak dollar is helping many U.S. private companies through a difficult period of slack domestic demand,” said Mike Hall, Grant Thornton LLP’s managing partner of Midwest Region. “The second half of 2008 may prove even tougher as global demand weakens and domestic spending takes a further hit from soaring oil prices. However, we expect a turnaround in household spending to support business turnover in 2009 as export sales suffer from a reviving dollar.”
While almost all key performance expectations surveyed in 2008 were down on levels seen in 2007 with the exception of selling prices; US businesses are slightly more optimistic about the nation’s economy over the next 12 months than in last year’s survey (22% for 2008 compared to 14% for 2007).
Globally, the majority of the key performance expectations surveyed had dropped from their 2007 numbers, with particularly marked falls in expectations for employment, profitability and investment.
The next 12 months are likely to be the most demanding that PHBs have faced in decades.
In addition to a sharp drop in optimism for Thailand and Japan there were some very pronounced declines in several other countries. These declines reflect serious concern in Ireland, Spain and the United Kingdom at the potential impact of the credit crunch and financial turbulence. The housing boom of recent years has been particularly strong in these countries, and the associated rise in credit has left consumers extremely vulnerable to a housing market collapse.
There is a real danger that a record 16 years of uninterrupted growth in the UK will end in the next few quarters.
UK optimism fell by 33 percentage points to its lowest level since 2006 when business sentiment was severely affected in the wake of terrorist activity in London.
Technorati Tags: economic-data, private-equity, privately-held-business
2007 was a “halcyon period” for private equity, according to a new study by Ernst & Young. PE exit returns, fundraising and deal volume all broke records during the year, though the latter six months were strongly affected by the global credit crunch.
E&Y’s sample of 100 PE companies outperformed public company benchmarks.
By smaller margins, PE businesses also increased their productivity.
Some of the Study’s key findings:
- 2007 exits grew company value by 24%, double that of public companies
- Deals in the 500 - 1 billion dollar range were the most successful.
- Germany was the year’s most successful geographic location: PE exit value growth outstripped public EV growth by 20 points.
- technology and telecoms were the highest growth sectors
- when enterprise growth was 32%, PE acquisitions had the highest rate of success.
The changing environment led many PE companies to become net sellers during the year, reaping significant cash windfalls.
Despite the worsening state of the economy over the year, strategies of PE-owned firms that focused on growth over core business activity had a greater average profitability. While the latter average was just 11%, the former was 17%.
Perhaps most importantly, E&Y found that the most successful PE firms shared a similar aggressive approach to building business value, reinforcing findings in other recent research on the subject.
Technorati Tags: private-equity
Overall credit quality is eroding and default risk rising among U.S. companies that were taken private through a leveraged buyout (LBO) over the last four years, a new study from Fitch Ratings shows. Rating Outlooks also point to further downward pressure on these credits in the months ahead.
In its study, Fitch reviewed 209 loan-financed LBO transactions executed between 2004 and 2007, accounting for approximately $293 billion in leveraged loan debt.
The analysis found that from the completion of an LBO through May 2008, the ratio of downgrades to upgrades among these firms was 3.3-to-1.0 and the average downgrade was 2.3 notches. Weak operating performance and an inability to generate sufficient cash flows to service post-LBO debt loads were the primary drivers behind approximately 80% of the downgrades. Additional post-LBO debt issuance used to fund a dividend payment to the equity sponsors of the LBO was the second most common driver, accounting for 15% of the downgrades.
While seasoning certainly plays a role in the distribution of downgrades through time, one indication of the toll current economic and credit market conditions are taking on these credits is that over one fourth of the downgrade actions and three of the four recorded defaults occurred during the first five months of 2008.
Looking ahead, it appears that these credits will come under increased pressure as approximately 44% of the LBOs examined had a Negative Rating Outlook as of May versus just 3% with a Positive Outlook.
The review also found that 23% of LBO credits examined consisted of firms in consumer cyclical industries and a further 15% were in the broad industrial category, evidence that a meaningful share of the LBOs brought to market in recent years are particularly sensitive to the type of macroeconomic weakness and consumer retrenchment the U.S. economy is currently experiencing. The recent bankruptcy of Linens ‘n Things is an example of this vulnerability.
While the study finds that Negative Outlooks exceed Positive Outlooks in all of the major sectors examined, consumer cyclicals and industrials lead the way in pointing to downward pressure on credit quality going forward.
The full report titled Credit Quality Weakens for Loan-Financed LBOs is available for purchase.
Technorati Tags: LBO, private-equity