Much has been written and spoken lately about the travails of the private equity industry – not least by the buy-out kingpins themselves, led by KKR co-founder Henry Kravis who, as the FT notes Wednesday, gave an “adapt or die” warning to the “inaptly named Super Return private equity conference in Berlin”. (As Lex wryly noted, calling a conference ” SuperReturn ” was, even in the good times, asking for trouble).
KKR, like other big buy-out groups, will be forced to do smaller deals, use less debt, and to diversify into other areas, such as infrastructure and corporate lending, he warned, highlighting how the biggest buy-out houses are being forced to fundamentally rethink their business models after years of relying on cheap debt to fund big acquisitions.
Ironically, Kravis’s remarks came around the same time rival firm TPG was finally giving up on long-running talks to sell a stake in itself to investors led by the Kuwait Investment Authority – up to recently one of the world’s most active sovereign wealth funds – and two Californian pension funds.
As first reported in the FT on Wednesday, the talks, which have limped along for two years, broke down over the issue of valuing TPG, and the firm has also given up any thoughts of an IPO – at least for the time being.
But wait – the collapse of TPG’s deal and related woes are not just about the problems affecting the buy-out industry. They speak volumes about the decline of the SWFs, portrayed little more than 20 months ago as voracious shopaholics bent on buying up the Western financial world.
Their “power and ambition initially drew a negative reaction from the west”, the FT noted recently, “but suspicions have evaporated as the financial crisis has deepened”.
For desperate bankers, and at one point, private equity groups, the Gulf’s sovereign vehicles – with estimates of their overall assets ranging up to $1,500bn – were seen as a last resort of funding. In a working paper put out 13 months ago by CFR’s Center for Geoeconomics, Brad Setser of CFR and Rachel Ziemba of RGE crunched some numbers and concluded that some estimates of the total combined size of Middle Eastern SWFs seemed “a bit too high”. But they were high enough to bring Western institutions in need of capital to their doorsteps.
We could not confirm recent estimates that the region as a whole has $3.5 trillion in external assets (counting private assets, including the undoubtedly large private assets of the al-Saud family), or the $800-$900bn estimates of ADIA’s size. We are more comfortable with an estimate of $2 trillion in total GCC external assets and an estimate of $650bn for ADIA [the Abu Dhabi Investment Authority].
Now, KIA is hurting, having acknowledged big paper losses in its investment in Citigroup, saying last September it had lost $270m. And total assets held by Gulf SWFs and ruling families fell from $1,300bn in 2007 to $1,200bn last year, according to a backgrounder on SWFs published by the Council on Foreign Relations.
The governments of Kuwait, Qatar and the United Arab Emirates have been particularly badly affected, the report argued, as funds under management have fallen from $1,000bn to $700bn.
Just as their performances have come under scrutiny, a local liquidity squeeze and sharp corrections in regional stock markets have led to debate about whether SWFs should, or will, focus more on their home markets, adds the FT:
The sharp decline in oil prices means that flows into sovereign vehicles will be lower than in recent years and there are also expectations that governments will use a greater portion of their surpluses to help finance projects that can no longer attract the necessary private sector financing.
The result is that western bankers have become “very sober about the potential for future engagement of sovereign wealth funds in Europe and the US”, says Steffen Kern, an analyst at Deutsche Bank.
“States are now focusing on their immediate economic needs, and that is a thing we see in the Middle East. We hear that funds from various countries are increasingly addressing domestic investments, like infrastructure projects, intended to help reignite their economies,” Mr Kern says. “At the same time we see cross-border investments have gone down substantially.”
That said, the funds are still investing – though much less in Western companies than in earlier years. Figures compiled by Deutsche show that of the known reported transactions – a tiny proportion of their overall investments – Middle East funds invested $21bn in 2007, compared to $7bn the previous year and $1bn between 1995 and 2004. In 2008, Deutsche forecasts it will be around the 2007 level.
However, caution has set in and the investments being made will undoubtedly not be in increasingly cash-strapped US private equity groups.
In a December report, the FT’s Middle East editor Roula Khalaf noted that “analysts agree that one of the likely developments in the region is a new wave of mergers and acquisitions, some backed by governments”.
The UAE has already provided a prime example: two of Dubai’s most important mortgage providers are being merged with banks owned by the federal government of the UAE. Analysts agree that one of the likely developments in the region is a new wave of mergers and acquisitions, some backed by governments. The UAE has already provided a prime example: two of Dubai’s most important mortgage providers are being merged with banks owned by the federal government of the UAE.
Deutsche Bank’s Kern, meanwhile, predicted “greater caution in the next few years”, as sovereign funds will be much more selective.
“But despite the caution, sovereign funds will not stop pursuing cross-border projects considering the low prices on the equity markets, and they remain highly attractive investors from the perspective of many public companies in Europe and America.”