Private equity’s “wall of money” is back at pre-financial crisis levels

A car transporter leaves the BCA Blackbushe car auction centre © Jason Alden/Bloomberg via Getty Images
Private equity group TDR Capital is buying car sales group BCA for £2bn

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Every bull market has a “wall of money” story.

The “wall of money” is a seemingly inexhaustible chunk of change that is ready, waiting and eager to flood into the market at any moment.

The “wall of money” is always so unimaginably vast that it becomes inconceivable that the bull market could ever end.

Because even if a few no-hopers decide to take profits, the “wall of money” is always hanging there, waiting for the opportunity to come cascading into the market and wash the bears away in a righteous flood of enthusiasm.

Before the financial crisis, the “wall of money” was in the sweaty palms of the sovereign wealth funds. Weirdly, that didn’t save the market in 2008.

This time round, the “wall of money” is held by private equity. Will that prove to be any more potent than previous walls?

I suspect not…

The problem with having lots of money is that you don’t spend it wisely

Private equity firms are sitting on almost $2.5trn of “dry powder”, according to data from Prequin, reported by the Financial Times.

For anyone who still struggles to visualise a trillion, then it’s $2,500bn (we’re using American billions here – so a billion has nine zeroes). Or you could say $2.5 million million.

However you want to phrase it, they have almost $2,500,000,000,000 to invest.

That’s a lot of money. I mean, to be fair, it’s not that much in the context of global markets. The US stockmarket alone has a market cap of more than $30trn. And let’s not even start on the government bond market – the chunk paying negative interest rates alone is worth around $13trn right now.

But nevertheless, it is a lot of money. And it is rather burning a hole in these investors’ pockets. The money comes from pension funds and sovereign wealth funds who are looking to make better returns than they can on other markets (and who are as prone to chasing the latest fad as every other group of human beings).

They’re not paying these private equity funds to stick that money under a mattress (or in negative-yielding government bonds). They’re paying them to hunt down fantastic deals and use that infamous private equity nous, ruthlessness and access to cheap leverage to turn a handsome profit (even after all the fees are paid).

As a result, according to one source quoted in the FT piece, “competition for assets is vivid”, which is an unusual but effective way to describe the rush to do business.

Of course, we all know what happens when “everyone has a lot of money”, as the same source puts it – prices go up. And when prices go up more rapidly than the quality of the underlying business, the value for money being achieved goes down. That means your expected future returns get hit.

But because “everyone has a lot of money”, no one cares about this last part. It’s true in the theoretical, conceptual world of tomorrow. But today, the money needs to be invested, the deals need to be done, and it’s all about that focus.

(You should read Barbarians at the Gate, the classic story of the leveraged buyout, if you haven’t already. The numbers have grown a lot bigger since then, but the egos and the focus on the dealmaking, and the way that momentum takes over and eclipses considerations of profitability, is still the same, I imagine. It’s also a very entertaining read, not a dry textbook.)

The private equity party is in full swing

So where are we now? The number of private equity deals has hit its highest since the financial crisis.

Indeed, one recent beneficiary has been everyone’s favourite troubled fund manager, Neil Woodford. Private equity group TDR Capital is buying car sales group BCA for £2bn, enabling Woodford to offload his stake in the company without too much pain.

That’s nice for poor old Neil. But what about those of us who see deal-making exuberance as a big red warning flag? On that front, the reassuring news is that we’re still well below the $400bn-plus value seen in 2008.

The bad news, of course, is that we’re less than half way through the year, and we’ve already breached the $250bn mark, and are ahead of the total deal volume seen in 2018. On top of that, “four private equity deals have eclipsed $10bn in size this year already, matching the number of mega deals clinched in 2018 as a whole.”

In other words, barring a massive slowdown in the second half, this is on course to be a record year for private equity deals, surpassing the 2008 total with ease. Meanwhile, the private equity groups are continuing to raise money for even bigger funds, to do even bigger deals.

Does this all mean the bubble will burst tomorrow? Of course not, timing these things is not an exact science and never will be.

But it’s a pretty convincing signal that we must be closer to the end of the party than to the start.