VideoA crucial factor will be whether private-equity firms can genuinely improve the companies they buy. Another will be how easily they can dispose of their investments. Without an "exit", there can be no profits. Two main exit routes — selling a firm to a big corporate buyer or floating it on a public stock market through an initial public offering (IPO) of its shares — have recently been much harder to pursue than in the past; and increasingly popular alternatives, such as selling to another private-equity firm, are becoming controversial.
Much will depend on how investors respond. On one hand, many have been disappointed at private-equity firms' average past performance; on the other, at a time when bonds and public equities are delivering historically low yields, the high returns generated by the best private-equity firms look increasingly enticing. European institutional investors, which have traditionally invested little in private equity, are beginning to show more interest. If investors pump more capital into an industry that arguably already has too much of it — especially now that hedge funds, flush with cash, are also piling into private equity — there is every chance of creating another bubble, hot on the heels of the one in venture capital.
Not only are good opportunities becoming harder to find, but being a maturing industry throws up other tricky issues. Many of the leading private-equity firms are still run by their founders, who are now getting to an age where they have to consider bowing out. As is often the way with charismatic founders, some may linger too long. And even when they go, the handover may prove highly disruptive as some of those passed over for the top job leave the firm. Nor can there be any guarantee that the next generation, clutching their MBAs, will inherit the deal-making magic of the founders.
Piggy in the Middle
Will tougher competition and increasingly demanding investors cause the industry to consolidate? Sir Ronald Cohen of Apax Partners thinks that over the next decade the private-equity industry will polarize. At one end, a few big global industry leaders will emerge — "maybe three or four dominant brands with high returns"; at the other, small specialist firms will thrive. In the middle, however, many firms will find it hard to compete. His prediction is plausible, and the losers may include some famous names. Forstmann Little has already said that it will close in 2006. It made some awful telecoms investments during the bubble and has failed to resolve its succession problem.
Some of the biggest private-equity firms are already staking out different territories. KKR and Apax say they will continue to concentrate on private equity. But Blackstone and Carlyle have been adding other financial products to their portfolio. Blackstone, for example, which has long run property funds, is toying with starting a hedge fund as well as beefing up its existing business providing advice on mergers and acquisitions. Diversification, these firms hope, will help them to exploit their expertise and brands — and perhaps to generate a more stable stream of profits that may allow them to float on the stock market one day. But critics ask whether there is any real synergy between the different sorts of "alternative assets" they offer.
Will private-equity firms be able to maintain their privacy when transparency is increasingly expected in every walk of life? The answer may depend on politics as much as on economics. Most private-equity firms fiercely oppose greater transparency, arguing that it will rob them of their magic. Many tacitly accept that their performance will soon become subject to much more intense scrutiny, and that they will have to adopt sensible industry standards for valuing their portfolios. But they are desperate to avoid having to disclose details about the performance of individual firms in their portfolios. Such disclosure, they say, would quickly subject those companies to the same sort of damaging short-term pressures that they would face in the public equity markets.
But change is on its way, if only because of the growing amount of money being invested in private equity through public pension funds. In America, freedom of information acts have prompted some public pension funds to provide details of the performance of their investments in different private-equity firms, to the horror of most of the firms concerned. Yet, as Thomas Lee, founder of the eponymous private-equity firm, concedes, "We are using so much public money that we have an obligation if not to be transparent then to be a little less invisible than in the past."
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