Sunday, August 31, 2008

LBO's Gone Wild

From The Economist:
To understand how private equity reached this position, consider the long-term prospects of leveraged buy-outs (LBOs), its core business. In 2006-07 the industry binged, buying companies with an enterprise value of $1.4 trillion. After adjusting for inflation, that is the equivalent to one-third of all the LBOs ever. Denial and rose-tinted accounting mean that losses on these investments have yet to be fully recognised. But the shares of listed buy-out funds are trading far below their book value and some clients, anticipating losses, are reportedly considering off-loading their interests in LBO funds.
Another corner of lending that I would be worried about, especially as profits begin to decline. Not to make it sound like a golden rule, but you should always be weary when activity surges in any financial corner. After all, remember that the final returns of all financial activity boils down to the underlying profits of American business. Market participants are constantly jockeying for a greater piece of the profit pie, and some do better than others. But we are dealing with 1.4 trillion dollars here. That means LBO firms found 1.4 trillion worth of securities that they thought that Wall Street was evaluating wrong-very wrong. Wrong enough where they could offer shareholders a 30% premium and still make out on top in the deal. I find it more likely that they were a little too optimistic in their projections.

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