In 2009, a year after the financial crisis began, David Rubenstein admitted that he’d gotten carried away.
“I compare it to sex,” the co-founder of private equity giant The Carlyle Group said at the time, at a conference at Harvard Business School. “You realize that there are certain things you shouldn’t do. But the need is there, and you can’t resist it.”
Seven years later, the markets have once again reached a fever pitch, with exaggerations that alarm investment bankers.
“Financial investors are once again paying maximum prices in corporate takeovers, prices that have reached the level of 2007 or are even higher,” said Rainer Langel, head of the German division of Macquarie Capital Advisers. This has him worried.
“The exaggerations cannot go well in the long term,” he said ahead of the private equity conference in Munich sponsored by Handelsblatt, which began on Wednesday. The industry is at the end of a cycle that usually lasts seven to eight years, he said.
Looking back, purchase prices for takeovers in Europe increased from 6.7 to 9.3 times operating profits between 2002 and 2007. And we are at an even higher level today.
“In some recent cases, buyers have paid 10 times operating profits for companies – in virtually all industries,” said Sven Baumann, head of German private equity operations for Citigroup. In some cases buyers have paid even more, which also reminds Mr. Baumann of the run-up to the 2008 financial crisis.
One of the more expensive takeovers in the last few months was the acquisition of the Hotelbeds Group by financial investor Cinven, together with the Canada Pension Plan. The duo paid the TUI Group just under €1.2 billion ($1.33 billion) for the travel services provider. With an operating profit of €69 million, this corresponds to 17 times earnings.
“Competition with strategic buyers from the industry is also driving up purchase prices,” said Wolfgang Taudte, a partner with consulting firm EY.
“In some recent cases, buyers have paid 10 times operating profits for companies – in virtually all industries.”
At the same time, there is growing interest from Chinese investors, as evidenced by electrical appliance manufacturer Midea’s bid for robot maker Kuka. According to banker Langel, there is more Chinese investor interest today than ever before.
Besides, it’s a sellers’ market for good companies, only a few of which are up for sale, according to Nicolo Salsano, co-head of Credit Suisse’s investment banking division in Frankfurt. But there are also ambitious players in the market, like family offices, which manage the assets of wealthy entrepreneurs, and sovereign wealth and pension funds, which are increasingly investing directly, thereby saving management fees and profit sharing, Mr. Baumann said.
Nevertheless, financial investors are swimming in money that needs to be invested. Private equity firm Advent, which made headlines with the sale of cosmetics retailer Douglas, launched a mega-fund in March, with $13 billion in managed assets. With German government bonds yielding negative interest, major investors like insurance companies and pension funds are desperately seeking alternatives. They include private equity funds run by firms like Advent, Carlyle and Warburg Pincus, which consistently generate double-digit returns. According to banking industry insiders, some investors are still demanding returns of 20 percent or more.
At the same time, the equity component in takeovers is declining, according to Macquarie executive Langel. “The ratio between risk and return is getting worse. When it comes to loans, the termination rules are being softened more and more, a phenomenon bankers refer to as covenant lite,” he said.
These loan softeners led to serious problems in the financial crisis and became a burden on the banks that issued the loans. Banks love financial investors, because they pay attractive interest rates for loans and tend to refinance their debts later on through high-yield bonds, generating commissions a second time around. As examples of covenants lite and warning signs, bankers cite the financing of the takeovers of the Kuoni Group, a travel services company, by EQT, of insulation manufacturer Armacell by Blackstone and of chemical manufacturer Novacap by Eurazeo.
But perhaps the Brexit could soon lead to a return to risk consciousness that would prevent further such deals.
Peter Köhler is an editor in Frankfurt, reporting on banks, private equity firms, venture capital and corporate funding. Robert Landgraf is Handelsblatt’s chief correspondent for the financial markets. To contact the authors: firstname.lastname@example.org, email@example.com