Can private equity only sell to its own?

“Personally, I just wouldn’t buy anything off private equity - they’ve had their chance. What does private equity do? They arbitrage the ignorance of fund managers. Well, we have kind of woken up.”

So says Andy Brough of Schroders, and he is speaking for many in the institutional investor world. Yet again we hear about the ‘Debenhams effect’ - a listed company taken private allegedly on the cheap, then refloated heavy with debt.

So is this the end for private equity? This year we’ve already seen abandoned IPOs from Merlin Entertainments and New Look, and a lot of other potentially mature private equity investments being held ‘until market conditions improve’.

But we’ve also seen Pets at Home sold by Bridgepoint to KKR for a handsome price.

So does this mean that private equity is stuck in a self-perpetuating clique - only able to sell to itself?

How does private equity drive value and can it still create value in a credit-constrained world? Should you sell a business to a private equity fund and finally, should you buy anything from private equity?

Historically private equity returns have come from a mixture of improving profitability, higher leverage and rising multiples. These days, any gain from high debt levels looks unlikely. Not many would gamble on market multiples rising over the next few years either. So private equity is increasingly going to have to look for sales growth and operational improvement to provide those returns.

Why would you refuse to sell a business just because the buyer’s private equity - or anyone else?

The argument that if private equity will pay X, then it must be worth much more than X, credits private equity with perfect vision. Why should they be all-seeing and fund managers just be ‘ignorant’? Look at HMV, which rejected an offer at 210p in 2006, and whose current share price is under 90p.

Who was right there? Should public shareholders buy a private equity-backed IPO? Ironically some institutions complain that private equity funds are dual-tracking IPOs and secondary sales to private equity. Private equity will often pay more than an IPO would raise.

But why would they do that if other private equity firms keep on selling over-valued businesses?

In fact, secondary deals like this are quite common because private equity often prefers to buy and sell to each other because of the greater certainty, privacy and shared methodologies.

The private equity industry needs to learn from past mistakes and adapt to the new environment. It needs to earn a reputation among institutional investors for being good sellers, as well as good buyers. 

But, however poorly Debenhams’ share price has performed since its IPO, this is just one example. How often do these critics mention Halfords, floated in 2004 at 260p and now trading on a handsome return at 480p?