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Investment Inflation Imminent?
[Analysis] Private equity continues to reach new heights
Thomas Johansmeyer (tomj)     Print Article 
Published 2008-04-26 15:32 (KST)   
Money continues to flow into private equity funds, and it all has to find a home somewhere. The continued investment of capital in private equity funds could contribute to a global "investment inflation" phenomenon, in which institutional investors are forced to pay higher prices just to make investor capital productive. Ultimately, returns are likely to be eroded.

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So far, money has been coming in, but it has had trouble going out. According to Private Equity Intelligence, Ltd. (Preqin), approximately 40 percent of the US$2 trillion in private equity assets under management globally is sitting on the sidelines. It seems as though there are not enough private investment opportunities to satisfy investor demand.

The money keeps coming, though, making the future even more challenging for private equity fund managers. In the first quarter of 2008, Preqin estimates that $163.5 billion in private equity capital was raised worldwide, marking only the second time that that more than $160 billion was raised in a single quarter. This last occurred in the second quarter of 2007.

The future seems to have more of the same in store. Preqin reports that 1,141 funds are currently hoping to raise $817 billion in capital. There has never been this number of funds on the road at once, and the amount of capital sought is record-setting as well. Tim Friedman, spokesman for Preqin, believes that the industry could raise $500 billion in 2008, as it did in 2007. In fact, he continues, "[W]e could even see $600 billion by the year end." If this does occur, the flow of capital could exceed that raised in 2007 by 20 percent.

Friedman sees the problem that this presents for private equity fund managers. "The challenge facing [private equity fund] managers will now be to invest the capital they have raised," he says, "and it appears likely that managers will be chasing a higher number of medium sized deals in 2008 rather than embarking on the mega deals that we have witnessed in recent years."

This is the fundamental problem of the private equity industry. There is an abundance of capital and a shortage of deals. Opportunities at the top end, such as the major private equity acquisitions of Toys "R" Us, will be far fewer in number. Mid-sized deals will become more popular of necessity, but the flocking of capital to this space is likely to drive prices up quickly. These deals, though more accessible, do not offer the economies of scale afforded by larger acquisitions. Transaction costs mount quickly, as lawyers, investment bankers and consultants still must be engaged. Thus, the returns generated have to be more productive than those for larger deals.

The next year likely will define the direction of the private equity industry. Clearly, dormant capital is not ideal, and a lack of returns will drive capital elsewhere, slowing the growth of this sector. Alternatively, desperation to make capital productive may lead to higher priced deals until the market cannot sustain itself, and a mid-sized company valuation bubble will swell ... and ultimately burst. Whatever the outcome, private equity cannot continue at this pace forever.

©2008 OhmyNews
Other articles by reporter Thomas Johansmeyer

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