Several people have asked lately what the implications of the current credit crunch and associated fall in the equities markets will have on the private equity market and on Pharos. The answer, as you might expect, is a bit complicated and a bit counter-intuitive. Overall, I would argue that it is a good thing for private equity in general, a good thing for Pharos, and a bad thing for hedge funds.
Lets start with how a credit crunch impacts private equity in general. First, the cost of completing leveraged transactions just went up, in many cases by at least 200 basis points. Some transactions won't get done, but those that fail will be deals there were either too leveraged anyway or where the fundamentals were questionable. Ironically by pulling the worst deals out of the pipeline, the credit markets are doing the private equity markets a favor. The `black eye' associated with failing to get a deal done is much less painful than the `black eye' associated with a large failed deal in the portfolio. By weeding out the worst deals, returns on private equity returns should improve in the out years. For the deals that do get done, it is certainly possible that returns decline, as more equity may be required or actual costs of debt exceed projections, but except for the most highly leveraged deals, these costs should be manageable.
The associated collapse in the equity markets is similarly a mixed bag. Obviously it pushes out some exits, and reduces the likelihood of some of the dividend recap transactions that pervaded the market for large deals the last couple of years; but prices for new transactions will be lower, and the market will ultimately stabilize and normalcy will be returned. The impact, therefore, will be short-term for some transactions in firms' portfolios, non-existent for others, and positive for new deals. All-in-all not much to worry about.
The impact on Pharos is probably more favorable overall than the market. Pharos focuses on adding value to its portfolio companies and generating returns for our investors through growth at the underlying companies, rather than simply leverage. Our portfolio companies are less leveraged than the markets, have higher growth rates than the markets, and have less need, on balance, for near term capital infusions. In other words, no big deal for now, and positive for the future because valuations should be lower for new deals.
Private equity ultimately is supposed to be an illiquid asset for investors. Investors are patient and rational, and by managing a portfolio of companies for the medium and longer term rather than for the next quarterly report to analysts, improvements can be made and value increased. Some firms have clearly forgotten this, and many firms including lots of hedge funds have come into the market and driven up prices with their high amounts of liquidity and large amounts of leverage. To the extent that these firms are ultimately shaken out of the market, that should be a good thing for the remaining private equity firms, like Pharos.
While no one likes watching the market decline every day and hearing the financial press talk about problems, the impact on the private equity world should be much less than for hedge funds, real estate funds, and other types of alternative investments. Here the core businesses are being hit, and confidence on the part of investors is being shalken. We will keep on going, building value, and hopefully delivering strong returns to our investors.
If you have any questions, feel free to post, and don't hesitate to take a look at our website