Is private equity in trouble?
Private equity has had quite a boom over the last couple of decades. Here are some stats: The number of private equity firms has grown from just 24 in 1980 to 17,000 in the U.S. alone today. In 2000, the global private equity market was $579 billion. Today it’s over $8 trillion.
We’ve reported on how private equity firms have bought up companies in everything from nursing homes to restaurants and real estate. But is there trouble ahead for private equity?
Jared Dillian, a financial author and trader, has been looking into private equity, and he does not like what he sees. His new report is called “The Next Big Short: Hidden Risks Behind Private Equity’s $8 Trillion Market.” Dillian discussed his views on the industry with “Marketplace Morning Report” host David Brancaccio. The following is an edited transcript of their conversation.
David Brancaccio: That space doesn’t look good to you?
Jared Dillian: No, it doesn’t. You know, private equity made sense at one point in history, if you go back about 10 or 15 years, in the 2010s, when interest rates were zero and valuations of private companies were like four or five times [EBITDA, or earnings before interest, taxes, depreciation and amortization]. And now interest rates are 5%, and valuations are 10 or 12 times — it doesn’t make a lot of sense. So what’s happening is that these private equity firms are competing in deals to buy companies at higher and higher valuations with an enormous amount of leverage, and I believe it poses systemic risks.
Brancaccio: Enormous amount of leverage because interest rates are higher. But, just for the many people listening who don’t fully understand this, private equity is open to wealthier investors, and they borrow. In the old days, at lower interest rates. They buy companies. Then what do they do?
Dillian: Crucially, they’re buying private companies, and they hold them for a period of time, usually three to five years. And they apply whatever management techniques to wring some efficiencies out of the business to increase the bottom line. And then they will sell the businesses to somebody else.
Brancaccio: And you’ve been looking at the numbers here. One of the things that you’ve noticed, you think is maybe a telltale sign, that private equity is holding the companies they’ve purchased, what, longer than before? What does that tell you?
Dillian: It’s difficult now for private equity firms to exit their investments. And what that means is that limited partners in private equity firms, the investors, are not getting cash distributions. So if you’re a pension fund or you’re an endowment and you have money in a private equity fund, usually this spits out cash over time. [Now] as companies get sold, they’re not getting any cash.
Brancaccio: And that’s an important point to make because it’s not just well-heeled investors above our income range that care. It may be that you’re into private equity because of your, for instance, pension fund.
Dillian: Yeah. I mean, university endowments have actually been the biggest proponents of private equity. And there was an article in Bloomberg the other day that talked about the Harvard endowment. And the Harvard endowment is now 39% of their portfolio in private equity. And that’s, that’s pretty similar across the board.
Brancaccio: Now we can’t know where all this leads. No one can. But, Jared, if you’re in a pessimistic mood with an imagination for disaster, are you worried that this downward pressure could lead to a bunch of private equity firms having trouble at once?
Dillian: Here’s the systemic risk, here’s the problem. So a stock market decline doesn’t last very long. Like even the financial crisis happened very quickly. But if you have 17,000 private equity firms liquidating their portfolios of companies over a period of five to 10 years, then it’s going to result in depressed valuations for a very long time. So the next bear market that we have could take longer than previous ones we’ve had in the past.
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