Jonathan Nelson of private equity shop Providence Equity had this to say at the Super Return conference in Frankfurt:
The model in our industry today is far different than the headlines would lead you to believe — and it’s far more sophisticated than it was 10 or even five years ago. In today’s environment, you have to improve businesses, not just arbitrage public and private capital structures. Or said another way, you must work on the income statement as well as the balance sheet.
Now I don’t doubt for a minute that private-equity shops are very sophisticated and that they don’t just buy, leverage, and flip. But I do think that in today’s environment of abundant liquidity and razor-thin spreads, it’s easier, not harder, to buy, leverage, and flip than it was five or 10 years ago. What makes Mr Nelson think that such a strategy can’t work any more? It certainly seems to be the main ingredient in most of the PE deals which hit the headlines, and which are nearly all funded with vast amounts of debt to layer on top of the debt which already exists in the target company.
I’d be more cynical still. A lot of PE investments have been in companies/industries buoyed ever upwards on the ‘Goldilocks’ environment, and there’s probably a certain amount of taking credit for making money in an environment in which it was difficult not to.
The litmus test of whether PE investors have really improved businesses will come if the current risk rebalancing spreads to credit. If/when it does, it’ll be interesting to see how many PE-backed companies can restructure their debt on the basis of solid earnings and reasonable debt/equity ratios and how many have to tap out and sell or ask for a govt handout.