In 2021 alone, more than 1,500 British companies, many of them well-known, went into private hands, including supermarket chain Morrisons, defense supplier Ultra Electronics and security giant G4S.
Private equity recorded $1.3 trillion worth of deals around the world, breaking the previous record of $670 billion set the year before Lehman Brothers’ collapse.
The lot was sold at a bomb price, so it’s likely to hold its value. But thousands of other works purchased in healthier times, when stock prices were high and debt was plentiful and cheap, are likely worth much less now that the music has suddenly stopped. .
However, Hook says this is not properly reflected in the numbers reported by the industry.
“When the U.S. stock market fell 20% in 2022, the private equity industry said its holdings had decreased by 0%, which defies rationality. It goes against all financial theory about the value of
There is no major industry that is not penetrated by acquisition capital. According to a McKinsey report released earlier this year, the private equity industry manages more than $6 trillion in assets globally.
But so-called “leveraged buyouts” (LBOs), in which the acquired company carries large amounts of debt on its balance sheet to finance its acquisition, are the most vulnerable to wild fluctuations in value.
There are approximately 700 LBO funds in the United States, managing more than 7,000 companies and investing approximately $1 trillion in equity. They account for an estimated two-thirds of the U.S. private equity market.
Hook believes these are the ones most likely to be overestimated. “In 2008, the American stock market fell by about 35%, but private equity (mostly LBOs) only fell by 20%. That’s just laughable.”
He estimates that if public markets decline by 31%, the value of highly leveraged private companies should fall by 67% due to the “magnifying effect of leverage on stock returns.”
The biggest concern is that private equity is essentially allowed to impose its own homework on the valuations of the companies it owns. A spokesperson for the UK Private Equity and Venture Capital Association said: “Private Capital Firm provides solid valuations that allow global institutions to invest in this asset class with confidence.
“The methodology and processes supporting the valuation are subject to regulation and annual external audits, performed in accordance with relevant accounting standards and at a frequency that meets investor requirements.”
But it’s more art than science. Owners are required under accounting rules to hold assets at “fair value.” This practice is known as “mark-to-market,” as opposed to providing real-time valuations, where private equity firms decide how to value an investment and when to change that valuation. is often derided as “mark-to-myth”. By the stock market.
The paper, written by Hook and economist Eileen Appelbaum of the Center for Economic Policy Research, says these are just “speculations.”
They point out that unsold companies are illiquid assets, meaning their “true value is not known until they are sold.” Worse, prices are likely to be “optimistically high” because fund managers who set prices have “little incentive to revalue them.”
Private equity houses typically buy companies with the intention of selling within three to five years. However, it is not uncommon for the largest funds to still have half their investments unsold after 10 years or more.
“The question then is, if the fund’s underlying investments have value, why is it that no one is buying them after so many years?” Hook asks.
Appelbaum points to the seemingly endless parade of failed stock market floats by private equity owners as further evidence of inflated valuations. Things have gotten so dire for some companies that private equity firms have resorted to buying back companies that have recently gone public.
Some major investors are also starting to have doubts. Vincent Mortier, chief investment officer at Amundi, a major French fund with nearly 2 trillion euros in assets, blames “cyclical” trading, in which private owners sell companies at inflated prices, at the top of the buyout world. He likens the club to a “pyramid scheme.” evaluation. “Just because there’s no marketable mark doesn’t mean there’s no risk,” Mortier said.
Mortier told the Telegraph this weekend that he did not intend to imply fraud.
But, he said, “the true value will only be known for sure if there is an exit through an IPO or sale to someone other than the private equity owners.”
Wellcome Trust’s Nick Moakes has recently written about private equity’s “private equity” policy, which can result in costly losses for investors who invest in the private equity space without properly understanding the risks of holding illiquid assets. He warned about culling.
Moakes calls this “tourist capital” – people who have invested in assets with “a risk profile that is inappropriate for them”. His Wellcome Trust, which manages £38 billion, is one of his largest charitable foundations in the world.
America’s financial police are imposing tough new rules on private equity, the real estate sector and hedge funds. The U.S. Securities and Exchange Commission (SEC) says the reforms, which include detailed quarterly performance reporting, will provide greater protection for investors in one of its toughest crackdowns in history.