From the FT Lex column:
A new “asset class” is being exposed as just another management and financing technique, and a pretty debatable one at that. But would a potential freeze in leveraged buy-outs be as bad for public equities as some fear? The argument that markets price in LBOs across the board is actually pretty weak.
Private Equity Intelligence provide an estimate for “dry powder” — committed equity as yet unspent — for buy-out funds. To this can be added the likely capital raised by private equity outfits on the road now, to produce a total of $548bn. It is reasonable to assume that this money is spent on takeovers which are three-quarters debt financed and which occur at a one-third premium to the stock market price.
On this basis, the total LBO takeover premium due to be paid to stock market investors is $506bn. This is only 2 per cent of North American and European market capitalisation. Of course, this might be concentrated in specific areas — mid-capitalisation stocks for example — and in certain countries, such as the UK. But if investors are accurately discounting the immediate pipeline of activity, anticipated LBO takeover premiums are not heavily distorting equity prices in aggregate.
Of course, stock markets might be discounting a much longer golden era of near-indiscriminate buy-outs. This is what fans of private equity predict: the underwriters’ research on Fortress Group, for example, is comically bullish, in one case predicting that assets under management will rise by 15 times by 2016.
Yet it is doubtful that public equity investors in aggregate accept this kind of “new paradigm” argument. If they believed the conditions were ripe for a sustained, massive rise in leverage, most big quoted companies would not have prudent balance sheets and be valued on earnings multiples that imply profits may be near a cyclical peak. Public equities probably reflect the view that the LBO boom is a cyclical phenomena of finite duration and questionable wisdom.