Private equity's dash for the exits

The long dormant IPO market has burst to life, with Australia swiftly following the lead set by the US.

If the mooted listings for the rest of the year proceed, 2013 could be the best year for floats in Australia since 2007 – a remarkable feat given the stale market environment just three months ago.

It has led some to boldly proclaim the good times are returning. But the actions of one key player, private equity, provide cause for caution.

According to James Katzman, a managing director in Goldman Sachs’ US investment banking division, private equity is charging for the exits.

“Why do private equity funds, who have tonnes and tonnes of money to invest, sit on $16 billion of funds and not spend a lot of it?” Katzman asks.

“Almost every single private equity firm, absent one or two, has been a significant net seller of assets this year. And they will all tell you – publicly or privately – that ‘we’re selling everything we can’.”

In Australia, the private equity-related listings on the agenda include Nine Entertainment, Dick Smith Electronics, BIS Industries, Vocation, Veda, GDI Property and Redcape. And that’s just before the end of 2013.

Former Woolworths subsidiary Dick Smith is arguably the best example of the scramble to cash out.

Just a year after it was acquired by Anchorage Capital, the group’s new owners are looking to cut and run.

Surely the private equity firm hasn’t extracted the full value they would have expected to reap in twelve months. But with the market bubbling, why would they take the risk of hanging onto an asset that promises such a great immediate return?

Speaking at the Annual Program for Financial Studies conference at Columbia Business School, Katzman explains why selling is now the main game for private equity firms.

“They’re doing it (selling) because they think asset prices are very, very high,” he asserts.

“We all know that asset prices have been effectively massively inflated over the last few years because the government has depressed interest rates so severely.”

As a result, private equity firms are worried about what happens when the ‘taper’ begins and rates eventually start rising.

“You’re giving them free money and they’re not taking it,” Katzman notes.

Helping fuel the IPO boom is, as Katzman suggests, the low-interest rate environment, with investors around the globe forced to look to typically riskier assets in the search for returns.

On the plus side, this is also a reason why the current uplift in activity – particularly in the US – is unlike, for example, the dot-com boom of 1999. Right now there are many good companies listing with the main issue that they may have to achieve incredible growth rates to justify the value ascribed. Compare this to the dot-com boom, when dreadful companies were attracting lofty valuations based on goals they could never hope to reach.

It’s preferable to have strong companies that are overvalued rather than weak companies that are overhyped. Nevertheless, it’s better to have neither and it’s easy to see why the taper has markets so jittery.

The true sign of a healthy market will be action on the M&A front. Katzman, who specialises in mergers, doesn’t see that on the horizon.