Private Equity Deal Makers See Increased Competition

BOSTON â€" Competition is heating up in the world of private equity.

With the industry collectively sitting on about $1 trillion in capital it must spend, a number of private equity executives have noticed an increase in competition for deals in the last year or so. Low interest rates and generous bank financing have also contributed to a market in which prices can rise to dizzying heights, deal makers say.

No private equity investor wants to admit to overpaying. But several say that, in the face of competing bids, they have been forced to sit on the sidelines more often than they would like.

“We’ve been a little less active than we would have liked to have been in the last 18 months,” Joseph Baratta, the global head of private equity at the Blackstone Group, said at a venture capital and private equity conference at Harvard Business School on Sunday. “We’re not finding that edge. We’re being a little more disciplined on that value metric.”

The increased competition underscores a major challenge facing private equity firms after a landmark year in which the industry returned more than $100 billion to investors. Now, with investors having entrusted these firms with even more money to spend, the private equity managers must find cheap investments at a time when stocks are near historic highs.

To do this, private equity firms are looking far and wide for idiosyncratic opportunities in which they can offer their own particular expertise, in addition to their capital. But that is no easy task, and the urgency of the challenge was on the minds of several of the prominent investors at Harvard this weekend.

Like Mr. Baratta, Candice Szu, a senior vice president at the Carlyle Group, emphasized the importance of finding an “edge” in competitive situations. That often means bringing a particular expertise in an effort to make an offer more compelling, she said.

“It’s something we always ask ourselves: What can we bring to the table that’s a little different?” Ms. Szu said on a panel at the conference. “You do have to find a little bit of an edge, otherwise you’re going to be just the guy who pays the most.”

Many firms were big sellers of their holdings in 2013, taking advantage of soaring stock markets. But when it came to new investments, the number of buyout deals announced last year fell 11 percent to 2,836, according to the data provider Preqin. The total value of those deals, however, rose 4 percent.

The market is further constrained by a lack of companies willing to sell, as they wait for the economy to improve further, said Milton J. Marcotte, head of the national transaction advisory services practice at McGladrey, an accounting, tax and consulting firm for private equity. That intensifies competition among buyers.

“We’ve been doing this awhile, and I don’t remember a time when it was really quite this competitive,” Mr. Marcotte said.

At the same time, private equity firms are under pressure from investors to complete deals. Buyout funds raised $169 billion in capital last year, an increase of 77 percent from 2012. That adds to the piles of money they raised in previous years â€" money that must be spent before a contractual deadline.

The flood of capital was due, in part, to market forces, private equity experts say. Many of the institutional investors in these funds, including pension funds and university endowments, aim to invest a certain fixed percentage of their assets in private equity.

Last year, private equity firms returned $124.1 billion to investors, according to an estimate by Cambridge Associates, a firm that advises investors in private equity. These investors then needed to commit more money to maintain their target level of investment.

In addition, a factor known as the “denominator effect” was at work, according to Jason Thomas, the chief economist of the Carlyle Group. This can occur when the value of pension funds’ total assets rises, helped by rising stock prices. That, in turn, compels pension funds to increase the amount of money they commit to private equity, as they look to maintain a target percentage.

Over the last year, public pension funds in the United States needed to increase their incremental commitments to private equity by about $20 billion to $30 billion just to keep up with those targets, Mr. Thomas estimated.

That creates a lot of “dry powder,” in private equity parlance, that must be spent. In addition, banks are increasingly willing to finance these risky deals, market participants say.

“The financing markets are virtually as hot as they’ve ever been,” Tenno Tsai, a managing director at the private equity firm H.I.G. Capital, said on Sunday. “I thought that awhile ago, and they just keep getting better. It’s a little crazy.”

That, combined with the Federal Reserve’s economic stimulus program, is helping prices climb higher, a source of worry to some.

“The artificially low interest rates are inducing people into doing things that might not be sensible in the fullness of time,” Mr. Baratta of Blackstone said.

David Humphrey, a managing director at Bain Capital, noted, “Valuations for clean, easily extractable businesses are quite high.”

Though private equity firms will continue to hunt for bargains, returns may not be as high in the future as they have been in the past, David M. Rubenstein, a co-founder and co-chief executive of Carlyle, said in a keynote speech on Sunday.

Mr. Rubenstein predicted that private equity would continue to be a better bet than the public markets. But he sought to temper the expectations of any Harvard students thinking of entering the industry.

“The days of getting fabulously rich in private equity may be a little bit behind us,” Mr. Rubenstein said.