One piece of terminology with which the Americans have enhanced the English language with economy and elegance is calling autumn “the fall”. We are now in the fall – of Wall Street, of US complacency or even, if the more extreme apocalyptists are to be allowed airtime, of Western capitalism itself.
It was as predictable as autumn following summer that the market for public flotations, or initial public offerings (IPOs) – as the US has with more typical clumsiness renamed them – would fall away with the global economy. The surprise for some might be the degree to which it has.
On the first day of October this week, when autumn is officially upon us – though mists and mellow fruitfulness seem singularly inappropriate in the current stormy climate – the depth of the fall in flotation activity was as starkly apparent as the branches of a denuded tree.
IPOs all but dried up in the third quarter of this year, and, according to capital markets data provider Dealogic, the volume of deals was down by some 61 per cent. With almost all IPO activity having dried up in the third quarter, the figures are grim – only &£40.5bn was raised in 545 flotations in the first nine months of this year, compared with &£106bn in the same period last year.
The period over which this decline has occurred makes it one downturn that cannot be directly attributed to the new world austerity born of September 11 – a date that has over the past couple of weeks become iconic in world history, like November 11 (Veterans Day). The fall in IPO activity is more likely to be attributable to the flotation activity of last year, when the appendage of a dot-com to corporate identities raised billions on Nasdaq and other markets.
In that sense, this downturn was predictable. What I have difficulty in understanding is why, when public equity dries up, private equity does too. As Dealogic was identifying the depth of the fall in IPO activity, the Centre for Management Buy-out Research was recording that the volume of leveraged buy-outs – those financed by borrowing against a company’s collateral – in the UK halved in the third quarter to &£4.5bn.
I understand that management buy-out (MBO) activity is likely to reflect business confidence and that in a downturn managers are unlikely to want to put their – or the banks’ – money where their entrepreneurial mouths are. And I also understand that banks are deeply unimaginative institutions, which tend to lend money for leveraged MBOs at the top of buoyant markets, only to watch the value of their invested money fall away with the economic cycle – and make their customers pay for it.
But it has always struck me that the private equity market should be bigger than the nervousness of the managements that it buys into and more sophisticated than the bone-headed banks, which will only lend you an umbrella when the sun is shining.
In the mid-cap sector of the publicly quoted markets, there was considerable unease during the Nineties that the trend towards index-tracking funds, which were unduly weighted towards the major stocks in each sector, was starving tomorrow’s potential FTSE 100 performers of the equity capital that they needed to grow.
The concern was so great among healthy mid-caps that some of the more innovative private equity houses were finding it as lucrative to fund companies coming out of a public listing, as it was in investing in private enterprises where the traditional profitable exit had long been the prospect of flotation.
Much of this get-rich-quick attitude should have changed with the deflation of the dot-com bubble and the more recent collapse of equities in what is now a full-blooded bear market. The emphasis is no longer on tracking indices that defy market gravity, but on spotting value where it is not recognised in share prices.
But my point is that the private-equity industry should be doing more deals when there is obvious value to be identified in the markets, rather than fewer. It’s a no-brainer that I, as an investor, would be more likely to want to participate in an MBO when my company is relatively undervalued than when it is near or at the top of its valuation. And it would seem logical that lenders should support me when there is a potential upside, rather than at the top of the market where there is much more of a potential downside.
A big part of the problem here has been the venture capital market. Instead of being participatory in the wealth-creation process, they have been parasitical. All too often, they have been the “vulture” capitalists who have sought as much equity for as little investment as possible, with the aim of a quick turnaround at flotation or a trade-sale exit.
This was particularly true of the so-called incubator funds that came out of the US in the dot-com boom. They made a forecast for the following quarter’s revenues seem unduly long-termist. It causes some pleasure to observe that many of the incubators have become body bags.
With globalisation looking, for a time at least, somewhat hubristic, and the public equity markets that have supported it rather inefficient, there is an opportunity for private equity to show its class. The big banks are hopeless at this end of the market, but one wonders where all those smart private equity fund managers are now, who assured us they weren’t in it for a fast buck when times were so good.
George Pitcher is a partner at communications management consultancy Luther Pendragon