Deal With It

Banks aren't lending, investor defaults are looming, and mark-to-market is a pain. But private equity CFOs are forging a path through the downturn.

Rather than chasing new deals, private equity firms are turning their attention to existing investments to make sure they come out on the other side of the economic slump in reasonable shape. “We’re monitoring our portfolio companies even more closely than previously,” says Graeme Murray, finance director of UK mid-market Dunedin Capital Partners. “One of the key messages across our investment portfolio and within the management company itself is the reduction of costs where possible and keeping close contact with our bankers.”

Though few CFOs have ever battled through a downturn as severe as today’s, private equity owners are hoping management teams at their portfolio businesses are clear about what needs to be done. “There’s a whole exercise around battening down the hatches and making sure the FDs and CEOs in those businesses really understand what’s likely to hit them,” says Rowland at Alchemy Partners. “We’ve got a few FDs and CEOs in our portfolio who have been there and done that and knew exactly what to expect. But there are some newer guys who haven’t really been through that cycle.”

For those who haven’t, there will be some tough decisions. A survey by investment bank Jeffries of 155 European private equity firms and banks found that 90% of German respondents, for example, say they foresee staff cuts at portfolio companies as the best way to beat the recession. (See “Differences of opinion.”)

Expectations of the dealmaking downturn

GMT’s Long says the key will be in CFOs’ ability to react quickly while still staying focused on the long term. “It’s easy to look at the mountains and it’s easy to look at the valleys and say, ‘[That long-term view] is nice,’” he notes. “But if you’re standing in the middle of a highway and there’s a ten-tonne truck coming towards you, you need to take some short-term actions. Some people in the past have not really done that—and have been hit.”

Get Real
One of the most significant struggles for private equity houses is valuing the businesses in their portfolios. The process is changing at many firms. At Mid Europa, for example, Morrow says he and managing partner Thierry Baudon used to take care of reviewing valuations. Today they’re scrutinised by every partner in the firm. Morrow, however, is hard to please. “In a fairly orderly market, we had relative confidence in our valuations,” he says. “In an entirely disorderly market, I have much less confidence that we can accurately value on a quarter-to-quarter basis, as required by mark-to-market [accounting], what our portfolios are worth.”

Indeed, Morrow isn’t the only private equity CFO who doesn’t necessarily think that mark-to-market is the right way to value a portfolio. The argument is that the only value investors should care about is the final value at which a business is sold—not an estimate of what it could be sold for at any given time. As Morrow sees it, if the company plans to exit a business in four years, using mark-to-market today “doesn’t bear any resemblance to reality.”


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