Financial Crisis - Super Return 20081015
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The Impact of the Financial Services Meltdown on The Global Economy And The Private Equity Industry
David Rubenstein, Co-Founder Super Return Dubai October 15, 2008 1
The Meltdown
2
How Did This Happen?
3
Excesses in The US Housing And Mortgage Markets Are A Root Cause ¾
Subprime loans accounted for 15% of the US mortgage market in 2006 vs. 3% in 2002 Subprime Share of Total Mortgage Market(1)
4
(1) Source: Danske Bank. March 30, 2008.
Excesses in The US Housing And Mortgage Markets Are A Root Cause ¾
The more than $600 billion of subprime mortgages that were issued in the US proved riskier than anticipated Mortgage Arrears Rates: Prime vs. Subprime(1)
Subprime Arrears rate: ~20% Prime Arrears rate: ~3.75%
5
(1) Source: Chicago Fed Letter, August 2007.
Excesses in The US Housing And Mortgage Markets Are A Root Cause ¾
To compete with private lenders, Fannie Mae and Freddie Mac lowered lending standards and provided mortgage loans to subprime borrowers GSE Mortgage Lending: Total Value & % of Market $3,000 bn
100%
Private mortgage lending
Percent Fannie & Freddie $1,500 bn
50% Fannie & Freddie
$0 6
0%
(1) Source: A Primer on the Mortgage Market & Mortgage Finance, St. Louis Fed. Reserve Bank. February 2008.
Excesses in The US Housing And Mortgage Markets Are A Root Cause ¾
Easy credit and lax lending standards fueled an unprecedented bubble in house prices Median US Home Price Relative to Owner’s Rent
7
Mortgages Were Packaged Into Structured Financial Products ¾
Trillions of dollars of asset backed securities and CDOs were distributed throughout the financial system Global Issuance of Structured Financial Products(1) ($ billions) 1,000
(in $B)
800 600 400 200 ‐ 1 1 1 1 1 1 1 1 1 1 1 1 1 1 Q 6Q 7Q 8Q 9Q 0Q 1 Q 2Q 3Q 4Q 5Q 6Q 7 Q 8 Q 5 9 9 9 9 9 0 0 0 0 0 0 0 0 0 19 19 19 19 1 9 2 0 20 20 20 20 2 0 2 0 20 20 Total CDO
8
(1) Source: Lehman Brothers, April 2008.
Total ABS
Financial Institutions Dramatically Increased Leverage Levels ¾
Investment banks, hedge funds, and even commercial banks used borrowed money to invest in structured financial products Bank & Broker Leverage Levels (Assets/Equity)
9
(1) Source: Citigroup. September, 17 2008.
Hedge Funds and Private Equity Firms Increased Their Use of Leverage ¾
Hedge funds and private equity firms control ~$2.5 trillion of equity but borrowed several times this amount to fund their investments
Private Equity Leverage Multiples(1) 6.5x
6.2x
6.0x 5.3x 5.4x
5.5x 5.0x
4.6x
4.5x 4.0x
Estimated Hedge Fund Leverage(2)
Leverage
4.8x
4.0x
3.5x 3.0x 2002 2003 2004 2005 2006 2007 10
Sources: (1) Morgan Stanley. September 2008. (2) McKinsey, October 2007.
Sovereign Wealth Funds And Central Banks Bolstered Global Liquidity ¾
Petrodollar inflows and exchange rate management policies resulted in massive capital accumulations throughout the developing world
Top Five Sovereign Wealth Funds(1) ($ billions) $875
Global Foreign Exchange Reserves(2) $ billions
4,987
5,000 4,309 3,822
4,000 3,112
3,000
$330
$250
2,000
$200 $108
2,093
2,475
1,000 0
ADIA 11
GIC
KIA
CIC
Temasek
Sources: (1) Monitor. May 12, 2008. (2) McKinsey, October 2007.
2001
2002
2003
2004
2005
2006
Rating Agencies Propagated The Illusion of A Low Risk Investment Environment ¾
¾
They assigned high, investment grade ratings to opaque structured financial products and debt issued by highly leveraged companies Since the outbreak of the credit crisis, they have downgraded over $1.9 trillion of mortgage backed securities Rating Agency Downgrades: Mortgage Backed Securities(1) ($ billions) 1,000
739
800
841
600 400 200
237 85
0
Q3 2007 12
Q4 2007
(1) Source: Citigroup. September, 17 2008.
Q1 2008
Q2 2008
The Bottom Line Is That Systemic Leverage Rose To Unprecedented Heights ¾
Total U.S. Credit Market Debt Has Risen to 350% of GDP %
Total Credit Market Debt / U.S. GDP
350
(1)
Today
330 310 290 270
Great Depression
250 230 210 190 170 150 130 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 13
(1) Source: Ned Davis Research, 2008.
Warning Signs
14
Default Rates Started to Rise ¾
Default rates on certain types of subprime mortgages had risen to above 20% (vs. 6% at the beginning of 2005) Mortgage Default Rates(1)
15
(1) Source: Freddie Mac, March 27,2008.
The Market Prices of Mortgage Backed Securities Fell Precipitously ¾
Market prices of mortgage backed securities had fallen dramatically by the end of last summer Price Performance of Asset Backed Security Indexes(1)
16
(1) Source: BNP Paribas, September 15, 2008.
Investment Banks Couldn’t Syndicate High Yield LBO Debt ¾
Private equity deals started to fall apart as debt markets re-priced risk and rejected complex structures Large LBO Failures Sallie Mae ($25.5 billion) Huntsman ($10.6 billion) Affiliated Computer Services ($8.0 billion) Harman International ($8.2 billion) Alliance Data ($7.8 billion) Penn National Gaming ($6.1 billion) United Rentals ($4.0 billion) Acxiom ($2.9 billion)
17
Investment Funds Lost Billions Betting on Risky Credit Instruments ¾
Two of Bear Stearns’ flagship hedge funds collapsed in July 2007 The funds had invested $1.5 billion in subprime CDO’s These failures were followed by the collapse of Sowood Capital, a prominent $3 billion hedge fund
¾
Structured Investment Vehicles (SIVs) announced billions of dollars of losses and were liquidated
18
They had borrowed heavily in the short-term debt markets to fund purchases of CDOs and other longterm, risky debt instruments
Systemic Risk
19
Financial Institutions Announced Massive Losses On Mortgages and Credit Instruments ¾
Financial institutions have sustained over $500 billion dollars of write-downs since the credit crisis began
$ bil
The IMF expects that total financial losses will exceed those of any past crisis IMF Comparison of Losses Across Financial Crises(1) Minimum Anticipated Future Losses
1,000 800 600 400 200 0 US Savings and Loan Japan Banking Crisis Crisis (1986-95) (1990-99) 20
Asia Banking Crisis (1998-99)
(1)International Monetary Fund, “Global Financial Stability Report,” April 2008.
Credit Crisis (2007- ??? )
Several Systemically Important Institutions Have Failed in the US ¾
21
Victims of the credit crisis:
Bear Stearns (investment bank) ― Saved from bankruptcy by government backed sale to JP Morgan
Lehman Brothers (investment bank) ― Bankrupt
AIG (world’s largest insurance co.) ― Bailed out
Washington Mutual (6th largest US bank*) ― Assets seized by the government and sold to JP Morgan
Wachovia (3rd largest US bank*) ― Sold to Wells Fargo after an aborted bid by Citigroup
* By deposits
A Radical Policy Response Seeks To Prevent A Systemic Collapse ¾
Under the Troubled Asset Relief Plan (TARP), the Treasury Department is:
¾ ¾
The FDIC is guaranteeing certain types of bank debt and has increased deposit insurance to $250,000 The Federal Reserve has taken extraordinary steps:
22
Purchasing up to $250 billion in equity stakes in US financial institutions, including $20-25 billion stakes in Bank of America, Citigroup, and Wells Fargo and $10 billion stakes in Goldman Sachs and Morgan Stanley Purchasing up to $700 billion of financial sector assets
Allowed banks to post unconventional assets as collateral Begun purchasing commercial paper from corporations Extended a $50Bn credit line to money market funds Begun paying interest on bank reserves
Europe
23
The Credit Crisis Has Struck Europe With A Vengeance ¾
Europe’s economies are in many ways as vulnerable as America’s
Leverage levels are high, house prices are inflated, and financial institutions have suffered deep losses
UK Household Debt/Income (%)(1)
Bank Leverage: Europe vs. USA(1) (Assets/Equity) 38x
21x
Europe 24
Source: (1) Citibank, “A Downward Spiral.” 17 September 2008.
USA
Large European Financial Institutions Have Experienced Extreme Distress ¾
In the United Kingdom
¾
In Germany
¾
Hypo Real Estate ― Bailed out by the German government
In France & Belgium
25
RBS ― The British government is recapitalizing Europe’s largest bank by assets HBOS & Lloyds TSB ― The UK government is injecting capital into both banks (Britain’s 4th & 5th largest), having already engineered their merger Northern Rock and Bradford & Bingley ― Two of the UK’s largest mortgage lenders became insolvent and were nationalized
Fortis ― Europe’s 11th largest bank was sold off piecemeal and partly nationalized Dexia ― France and Belgium were forced to recapitalize Europe’s 16th largest bank
Other Systemically Important European Banks Are at Risk ¾
Many of Europe’s largest banks operate at very high leverage levels
One reason is that many of them have highly leveraged investment banking operations European Banks’ Leverage Ratio Compared With Citigroup(1)
Citigroup
26
Source: (1) Greed & Fear, 09 October 2008.
European Governments Have Been Forced To Take Radical Action
27
¾
European governments have pledged a total of $2.5 trillion to guarantee bank debt and purchase equity stakes in financial institutions
¾
Eurozone governments have agreed to guarantee all new bank debt issuance through 2009
¾
Ireland, Germany, and Denmark have guaranteed all consumer bank deposits
¾
European central banks are offering unlimited dollar funding to banks in order to unclog interbank lending
European Governments Have Been Forced To Take Radical Action ¾
28
Specific national policies include:
The UK Government is guaranteeing bank debt and injecting ₤50 billion into banks including RBS, HBOS, and Lloyds TSB
Germany is guaranteeing up to $544 billion of bank debt and plans to buy equity stakes worth up to $109 billion
France is creating a state fund to buy stakes in financial institutions and has guaranteed $435 billion of bank debt
Spain is guaranteeing up to $136 billion of new bank debt, has set up a facility to purchase equity stakes, and plans to buy up to $68 billion of bank assets
Iceland has nationalized its entire banking system and may borrow billions of dollars from Russia and the IMF
Source: Wall Street Journal, 14 October 2008.
Emerging Markets
29
Emerging Markets Have Posted Steep Stock Market Losses ¾
Heightened risk aversion, capital flight, and deteriorating economic growth prospects have produced dramatic equity price declines YTD Performance of EM Equity Markets(1)
120
100
S&P 500: (38.8%) India: (48.1%)
80
Asia: (52.2%)
60
30
MSCI Latin America
MSCI Eastern Europe
India (SENSEX)
US (S&P 500)
Source: (1) Bloomberg, 10 October 2008.
MSCI Emerging Asia
Sep-08
Sep-08
Aug-08
Aug-08
Jul-08
Jul-08
Jul-08
Jun-08
Jun-08
May-08
May-08
Apr-08
Apr-08
Mar-08
Mar-08
Feb-08
Feb-08
Jan-08
Jan-08
40
Jan-08
Lat. America: (60.9%) E. Europe: (62.2%)
The Credit Crisis Has Disrupted Capital Markets and Exposed Fiscal Weaknesses ¾
Regions and countries with major fiscal imbalances have been hit hard
¾
31
Many emerging markets rely on foreign capital inflows to finance large current account deficits They have funded domestic credit growth with foreign borrowing Some developing economies are heavily commodity dependant and will weaken as commodity prices fall
Capital flight is a major risk for these economies
Certain Emerging Markets Are Vulnerable ¾
¾
Emerging markets with high current account deficits and tight banking sector liquidity could experience full-blown financial crises Regions/Countries at risk include: Central & Eastern Europe ― The Baltic states, Bulgaria, Romania, Ukraine, and Hungary have large current account deficits and have experienced unrestrained credit growth Latin America ― Countries including Brazil, Peru, Argentina, and Venezuela could see their fiscal positions deteriorate if commodity prices fall further Pakistan ― The country’s credit ratings have been cut due to its deteriorating external liquidity situation and dwindling foreign reserves
32
Certain Emerging Markets Are Vulnerable ¾
Eastern European current account deficits and Latin American commodity dependency are key vulnerabilities Certain CEE countries will experience credit contractions, reduced investment, and slower growth Latin American governments may have to raise taxes or cut spending as commodity related revenues fall
CEE Current Account Deficits(1) (2007) 0% -5%
-4.9%
-10% -15%
8.7% 1.8%
-2.0% -5.0%
-18.2% -22.0% Bulgaria
33
2007 Actual 2007 Pro-forma 1.1%
1.7%
-13.7%
-20% -25%
-5.3%
Lat. Am. Fiscal Balances Pro-Forma for Commodity Prices at 10 Yr Avg.(2)
Baltic Romania Hungary United States States
-2.6%
-8.1% Argentina
Brazil
Chile
Sources: (1) Economist Intelligence Unit, 13 October 2008; (2) Morgan Stanley, 30 September 2008.
Peru
What About India? ¾
India has benefited from rapidly increasing capital inflows since 2000, but these are set to fall
Capital inflows funded investment and boosted GDP growth above its long-term sustainable rate Capital Inflows Received by India(1) $ billions
98
100 50 10
21
39
0 2000-2 Avg. 2003-5 Avg.
¾
2007
But India should prove relatively resilient due to growing domestic demand low reliance on exports
34
2006
Growth is likely to moderate to a more sustainable rate of ~6-7% (from a 3-year average of 9.3% as of March 2008)
Sources: (1) Morgan Stanley, 30 September 2008; (2) Carlyle Analysis.
What About China? ¾
Of the world’s major economies, China’s is best positioned to weather the storm Key reasons include: 1. China has amassed $1.8 trillion of foreign currency reserves as a result of its persistently high current account surpluses 2. The economy benefits from a very low level of leverage and low external debt ― debt levels for households and the government are only 13% and 33% of GDP, respectively 3. Domestic banks remain awash with liquidity as a result of deposit growth and reserve accumulation 4. The banking system in China operates on a conservative basis with low leverage levels and without securitization
35
Sources: (1) Morgan Stanley, 07 October 2008; (2) Carlyle Analysis.
Recession in The West Will Affect Chinese Growth Prospects Transmission mechanisms include: ¾
Trade
¾
Investment
¾
Western investors have supplied much of the capital that has been used to grow China’s companies
Opportunities for International Expansion
36
Western economies are key consumers of Chinese exports
Many of China’s most successful companies – such as Lenovo and Bank of China – are expanding abroad
But China Will Continue to Grow Rapidly ¾
24%
Domestic growth will offset weaker external demand
An increasing proportion of GDP derives from domestic demand
China’s growing middle class has rapidly increased its consumption of items like cars and electronics
Abating inflationary pressures will allow China’s central bank to further loosen monetary policy Chinese Retail Sales (% Change YoY)(1)
22% 20% 18% 16% 14% Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug08 08 08 08 08 08 08 07 07 08 07 07 07 07 07 37
(1) Source: China Statistics Bureau, August 2007.
The Middle East
38
The Middle East Is Likely To Prove Resilient ¾
The credit crisis is affecting the Middle East but not as much as other regions
¾
¾
Nevertheless, the credit crisis in the West has precipitated a regional liquidity contraction
Foreign banks in the region have stopped lending money
Regional stock markets have posted dramatic declines
Local banks are generally healthy
This cloud has a silver lining
39
The IMF forecasts only a slight moderation of GDP growth to 6.0% in 2009 (vs. 6.5% in 2008)
The credit down-cycle and falling food and energy prices are moderating inflationary pressures
Sources: IMF World Economic Outlook, October 2008; Emerging Markets Monitor, 6 October 2008
Oil Price Declines Are Significant But Not Disastrous ¾
Economic growth is being sustained mainly by non-oil sectors including construction, retail, transportation, and financial services Middle Eastern GDP Growth: Oil vs. Non-Oil Sectors (1) %
40
Source: IMF World Economic Outlook, October 2008
Oil Price Declines Are Significant But Not Disastrous ¾
Most government budgets and investment programs in the Middle East will remain intact unless oil falls below $50/barrel
¾
41
A prolonged drop below $50 is highly unlikely because global demand for oil continues to rise while supply is largely static
Middle Eastern governments have amassed huge reserve funds which they could deploy to support regional growth if the outlook darkens
Middle Eastern government saved 70% of their surplus oil revenues over the past five years
Sovereign wealth funds in the MENA region have over $1.5 trillion at their disposal
Sources: Monitor Group, “Sovereign Wealth Funds and the MENA Region,” 12 May 2008; Carlyle research & analysis.
The Current Situation
42
Central Banks Have Responded With Coordinated Global Rate Cuts ¾
On October 8th, 21 countries around the world simultaneously cut interest rates
The Federal Reserve cut the federal funds rate by 50 basis points to 1.50% October 8th: Key Interest Rate Cuts(1)
43
Source: (1) Financial Times, 08 October 2008.
Credit Market Stress Remains At Unprecedented Levels ¾
But global interest rate cuts have done nothing to encourage private sector lending
The spread between US Treasuries and the interbank lending rate remains at all time highs TED Spread: 3 month LIBOR – 3 month T-Bill(1)
44
Source: (1) BNP Paribas, 10 October 2008.
Global Equity Markets Have Crashed ¾
Global stock markets are testing multi-year lows
The MSCI World index has fallen by over 40% since its 2007 high MSCI AC World Index(1)
45
Source: (1) Greed & Fear, 09 October 2008.
Commodity Prices Have Retreated ¾
The price of oil has fallen by 40% since its peak in July 2008 Oil Price/Barrel Since January 1st (1) 150 140 130 120 110 100 90
Ja n-0 8 Ja n-0 8 Fe b-0 8 Fe b-0 8 Fe b-0 8 Ma r-0 8 Ma r-0 8 Ap r-0 8 Ap r-0 8 Ma y -0 8 Ma y -0 8 Ju n-0 8 Ju n-0 8 Ju l-0 8 Ju l-0 8 Au g -0 8 Au g -0 8 Au g -0 8 Se p -0 8 Se p -0 8 Oc t-0 8
80
46
Source: (1) Bloomberg, 10 October 2008.
Consumer Access to Credit Is Dwindling ¾
US Consumer credit fell by a record $7.9 billion in August
This was the first drop since 1998 and the largest monthly decline in history Monthly Net Increase in Consumer Credit Outstanding(1)
47
Source: (1) Greed & Fear, 09 October 2008.
The United States Is Falling Into Recession ¾
Unemployment rose to 6.1% in August from 5.7% in July
¾
Retail sales fell by 0.3% in August and were down 0.7% excluding automobile sales
¾
The main index of US manufacturing activity fell 13% in September
¾
The current level has only been seen before during full-blown recessions
US GDP growth is slowing significantly, and outright contraction is likely
48
The 1.1% surge in the unemployment rate over the past 4 months is the fastest in 22 years
Goldman Sachs forecasts US GDP growth of 1.5% in 2008 and -0.2% in 2009 (vs. 2.0% in 2007)
Much of the Rest of the World May Follow in America’s Footsteps ¾
Economists are ratcheting down global growth estimates Key factors likely to suppress growth: Decreased global liquidity Lower capital flows to emerging markets Reduced G-7 demand for imports Lower demand for commodities
¾
49
Key 2009 GDP growth forecasts* 2009E
2008E
2007A
Euroland
0.5%
1.1%
2.6%
United Kingdom Japan China
0.4% 0.5% 8.7%
1.0% 0.7% 9.8%
3.0% 2.1% 11.9%
Brazil
3.3%
5.6%
5.4%
* Goldman Sachs, 10 October 2008.
What’s Next?
50
Markets Will Recover From Recent Lows Investor panic had driven valuations to levels which were not warranted by fundamentals ¾ Monday’s rally may mark the beginning of a medium term rally ¾
¾
But this does not mean that equity markets won’t touch recent lows again in the future
51
It marked the largest ever one-day point gain for the Dow Jones Industrial Average and the largest percentage increase since 1933
Volatility may return as the deleveraging cycle continues and as a consumer recession sinks in
A Broader Recession Will Ensue ¾
85%
Tighter credit and lower house prices will severely depress consumption Home Price % Change vs. Previous Cycle (1) 66%
65%
70%
% of US Banks Tightening Consumer Credit (2)
50%
45% 25%
30%
20%
10%
5% -17%
-15%
20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08
-12%
-35% 1983-89 52
1990-95
-10%
1996-06
2007Present
Credit cards
Other consumer loans
Sources: (1) Zellman and Associates. September 2007; (2) The Federal Reserve Bank Officer Lending Survey, July 2008
The Deleveraging Process Will Be Unpleasant And Will Take Time ¾
Debt levels need to become more sustainable before an economic recovery can ensue %
Total Credit Market Debt / U.S. GDP
(1)
350 330 310 290 270 250 230 210 190 170 150 130 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 53
(1) Source: Ned Davis Research, 2008.
The Future Is Still Bright: Extraordinarily Positive Long-Term Macro Trends Exist ¾
¾
¾
Rapid growth of emerging markets
Billions of people will achieve relative prosperity
Opportunities for investment and development will abound
Technological innovation
Technology is evolving at a more rapid pace than at time in human history
This will increase productivity and living standards globally
Improvements in science and medical technology will directly benefit millions of people
Global peace and stability
54
The world is a more stable place than it has been for most of the past thousand years
Impact on Private Equity
55
Existing Investments Will Be Affected ¾
2000-2005
LBO activity boomed but leverage levels and acquisition multiples remained reasonable
Most deals done during this period will prove resilient
Global LBO Activity 2000-2005(1) $ Billions
291
300 247
250
100
110
102
Leverage Acquisition
8.0x
6.4
5.0x
65
4.0x
8.1 7.0
6.7
6.4 5.8
6.0x
142
50
4.2
4.1
4.6
4.8
5.3
4.0
3.0x
0 2000 56
9.0x
7.0x
200 150
Leverage vs. Acquisition Multiples(1) (of EBITDA)
2001
2002
2003
2004
2005
Sources: (1) Dealogic. (2) Standard & Poor’s.
2000
2001
2002
2003
2004
2005
Existing Investments Will Be Affected ¾
2006-1H 2007
A bubble developed in the private equity market
Debt and acquisition multiples rose above historical norms
Some companies bought during this period may experience financial difficulties Global LBO Activity(1)
$ billions
700 600 500 400 300 200 100 0
693
EBITDA Multiple
8.7x
6.0x 4.0x
160
2000-2005 Avg. 57
Leverage vs. Acquisition Multiples(1)
5.8x
8.0x
6.7x
6.0x
4.5x
4.0x
2.0x
2006-2007 Avg.
0.0x
10.0x
2.0x 0.0x 2000-2005 Avg.
2006-7 Avg.
2000-2005 Avg.
Sources: (1) Dealogic, Standard & Poor’s, Morgan Stanley Financial Sponsors Group, Carlyle Analysis.
2006-7 Avg.
Existing Investments Will Be Affected ¾
2H 2007
After the credit crisis hit, many deals met with difficulty
Investment banks could not syndicate LBO debt and a massive $389 billion debt backlog developed
Many deals were pulled; others were renegotiated on more favorable terms Busted Deals(1)
58
Restructured Deals(1)
Company
Value
Company
Value
Sallie Mae
$25.5 billion
ClearChannel
$27.3 billion
Huntsman
$10.6 billion
First Data
$26.3 billion
Harman Int.
$8.2 billion
Harrah's
$26.2 billion
ACS
$8.0 billion
Biomet
$11.4 billion
Alliance Data
$7.8 billion
HD Supply
$8.5 billion
Penn National
$6.1 billion
Thomson
$7.8 billion
Source: (1) Morgan Stanley Financial Sponsors Group.
New Private Equity Deals Look Different ¾
Private equity deals are smaller Average Deal Size (1)
$ Millions
600 519 500
Credit Crisis
422 400 300
294 251
200
171
155
143 97
100
134
0 2006 Q3 59
2006 Q4
Source: (1) Dealogic.
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
New Private Equity Deals Look Different ¾
Private equity deals involve more equity Average Equity Contribution (% of Purchase Price) (1)
40% 38% Credit Crisis
36% 34% 32% 30% 28% 26% 1997 60
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
1H08
2Q08
New Private Equity Deals Look Different ¾
Private equity deals involve less favorable debt terms Average Spread of Leveraged Buyout Loans (1) (vs. LIBOR)
bps
450
400 Credit Crisis
350
300
250 1997 61
1998
1999
2000
Source: (1) Standard & Poor’s.
2001
2002
2003
2004
2005
2006
2007
1H08
2Q08
New Private Equity Deals Look Different ¾
Private equity deals are fewer in number Number of Private Equity Deals
700
666
650 600
655 615
582
Credit Crisis
620
613
585
582 550
550 500
448
450
410 400 350 300 Q1 06 62
Q2 06
Q3 06
Source: (1) Standard & Poor’s.
Q4 06
Q1 07
Q2 07
Q3 07
Q4 07
Q1 08
Q2 08
Q3 08
New Private Equity Deals Look Different ¾
Private equity deals are less debt-dependant Minority Investment by Financial Sponsors (1)
Minority Investments ($ billions)
25
24
35%
% of Total PE Deal Volume Minority Investments
20
30%
15
15 10
% of Total PE Deal Volume
25%
16
20%
13 10
10
10
10
10
8
7
10%
5
5%
0
0% Q1 06
63
15%
Q2 06
Source: (1) Dealogic.
Q3 06
Q4 06
Q1 07
Q2 07
Q3 07
Q4 07
Q1 08
Q2 08
Q3 08
New Private Equity Deals Look Different ¾
More private equity firms are investing alongside corporate partners or sovereign wealth funds
¾
Holding periods will rise as private equity firms spend more time improving portfolio companies’ operational performance
64
Recent examples include Blackstone and NBC Universal’s $3.5 billion joint acquisition of the Weather Channel
Many exits will be delayed until the financial crisis subsides
Source: (1) Dealogic.
Private Equity Returns May Rise
Vintage Year IRR (%)
35
Private equity deals done during periods of economic difficulty tend to outperform U.S. Buyout Funds - Vintage Year Returns
30
30
25
25
20
20
15
15
10
10
5
5
0
0
-5
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000² 2001 2002 2003 2004 Median
65
35
Upper Quartile
Source: (1) Morgan Stanley Financial Sponsors Group.
5-Year Forward-Rolling S&P 500¹
-5
S&P 500 Annualized Return (%)
¾
Private Equity Trends
66
Several Key Trends Will Affect The Private Equity Industry
67
¾
Fewer lenders will provide debt to fund acquisitions
¾
Private equity firms will face less competition from investment & commercial banks
¾
Distributions to limited partners will fall in the medium term
¾
Decreased global liquidity will result in reduced commitments to new private equity funds
¾
There will be more co-investment opportunities
¾
There will be fewer PE commitments from high net worth individuals
¾
The terms of private equity partnerships may change
¾
Public perceptions of the PE industry will improve
Four Big Questions Confront The Industry
68
1.
Will governments intensify the regulation of the private equity industry?
2.
Will tax rates on private equity distributions rise?
3.
How will the industry’s public image evolve?
4.
Can the basic private equity business model still work?
Opportunity & Challenge
69
Private Equity Now Has Its Greatest Opportunity And Its Greatest Challenge ¾
70
Opportunity: To use its capital and expertise to save companies and turn them around
An enormous number of companies will now need fresh capital ― private equity has the necessary capital
Low prices can yield attractive returns ― perhaps the best ever
Private Equity Now Has Its Greatest Opportunity And Its Greatest Challenge ¾
71
Challenge: Overcoming the widespread conception that private equity firms are short term investors
The industry needs to recognize that turnarounds will not be easy
Private equity firms will be operating under an even greater level of public scrutiny
Maintaining investor confidence will be critical
The Opportunity And The Challenge Are Particularly Great In Financial Services
72
¾
Opportunity: To help strengthen financial institutions around the world, often working closely with governments in this endeavor
¾
Challenge: To restore confidence in financial institutions during times of unprecedented market disruption
Private Equity Now Has Its Greatest Opportunity And Its Greatest Challenge ¾
73
Bottom Line: This could well turn out to be private equity's finest hour ― if the industry moves carefully and skillfully to help with the global economic turnaround, partnering at times with corporations, sovereign wealth funds, and governments
Private Equity in the MENA Region
74
Key Predictions
75
¾
Private equity activity may moderate but will remain strong
¾
Demand for investment capital from companies in the region will rise
¾
Local private equity firms will be the most active investors
¾
Some new global players will enter the market
¾
Minority state transactions will predominate
¾
Investment opportunities will be better than before
¾
Sovereign wealth funds in the region will focus more of their attention on the region
Lower Stock Market Valuations Could Be A Boon For Private Equity Investors ¾
Regional stock markets have fallen because they were previously over-inflated
Investors had pushed up valuations to unsustainable levels
Many of them have withdrawn capital because the credit crisis has increased risk aversion and demand for cash
GCC Stock Market Performance
76
GCC P/E Ratios
Lower Stock Market Valuations Could Be A Boon For Private Equity Investors ¾
Private equity investors can now buy assets at prices that are very attractive from a long-term perspective
77
The MENA region’s robust growth prospects and insulation from the credit crisis make it one of most attractive areas in the world for private equity investment
Conclusions
78
Key Conclusions
79
¾
The world of private equity will change – for many years – as a result of the credit crisis and the unfolding economic slowdown
¾
The MENA region will be affected by changes in the United States and Europe
¾
The appeal of the MENA region will increase ― although investment activity may moderate, it will be higher than in many other regions
The Impact of the Financial Services Meltdown on The Global Economy And The Private Equity Industry
David Rubenstein, Co-Founder Super Return Dubai October 15, 2008 80
David Rubenstein, Co-Founder Super Return Dubai October 15, 2008 1
The Meltdown
2
How Did This Happen?
3
Excesses in The US Housing And Mortgage Markets Are A Root Cause ¾
Subprime loans accounted for 15% of the US mortgage market in 2006 vs. 3% in 2002 Subprime Share of Total Mortgage Market(1)
4
(1) Source: Danske Bank. March 30, 2008.
Excesses in The US Housing And Mortgage Markets Are A Root Cause ¾
The more than $600 billion of subprime mortgages that were issued in the US proved riskier than anticipated Mortgage Arrears Rates: Prime vs. Subprime(1)
Subprime Arrears rate: ~20% Prime Arrears rate: ~3.75%
5
(1) Source: Chicago Fed Letter, August 2007.
Excesses in The US Housing And Mortgage Markets Are A Root Cause ¾
To compete with private lenders, Fannie Mae and Freddie Mac lowered lending standards and provided mortgage loans to subprime borrowers GSE Mortgage Lending: Total Value & % of Market $3,000 bn
100%
Private mortgage lending
Percent Fannie & Freddie $1,500 bn
50% Fannie & Freddie
$0 6
0%
(1) Source: A Primer on the Mortgage Market & Mortgage Finance, St. Louis Fed. Reserve Bank. February 2008.
Excesses in The US Housing And Mortgage Markets Are A Root Cause ¾
Easy credit and lax lending standards fueled an unprecedented bubble in house prices Median US Home Price Relative to Owner’s Rent
7
Mortgages Were Packaged Into Structured Financial Products ¾
Trillions of dollars of asset backed securities and CDOs were distributed throughout the financial system Global Issuance of Structured Financial Products(1) ($ billions) 1,000
(in $B)
800 600 400 200 ‐ 1 1 1 1 1 1 1 1 1 1 1 1 1 1 Q 6Q 7Q 8Q 9Q 0Q 1 Q 2Q 3Q 4Q 5Q 6Q 7 Q 8 Q 5 9 9 9 9 9 0 0 0 0 0 0 0 0 0 19 19 19 19 1 9 2 0 20 20 20 20 2 0 2 0 20 20 Total CDO
8
(1) Source: Lehman Brothers, April 2008.
Total ABS
Financial Institutions Dramatically Increased Leverage Levels ¾
Investment banks, hedge funds, and even commercial banks used borrowed money to invest in structured financial products Bank & Broker Leverage Levels (Assets/Equity)
9
(1) Source: Citigroup. September, 17 2008.
Hedge Funds and Private Equity Firms Increased Their Use of Leverage ¾
Hedge funds and private equity firms control ~$2.5 trillion of equity but borrowed several times this amount to fund their investments
Private Equity Leverage Multiples(1) 6.5x
6.2x
6.0x 5.3x 5.4x
5.5x 5.0x
4.6x
4.5x 4.0x
Estimated Hedge Fund Leverage(2)
Leverage
4.8x
4.0x
3.5x 3.0x 2002 2003 2004 2005 2006 2007 10
Sources: (1) Morgan Stanley. September 2008. (2) McKinsey, October 2007.
Sovereign Wealth Funds And Central Banks Bolstered Global Liquidity ¾
Petrodollar inflows and exchange rate management policies resulted in massive capital accumulations throughout the developing world
Top Five Sovereign Wealth Funds(1) ($ billions) $875
Global Foreign Exchange Reserves(2) $ billions
4,987
5,000 4,309 3,822
4,000 3,112
3,000
$330
$250
2,000
$200 $108
2,093
2,475
1,000 0
ADIA 11
GIC
KIA
CIC
Temasek
Sources: (1) Monitor. May 12, 2008. (2) McKinsey, October 2007.
2001
2002
2003
2004
2005
2006
Rating Agencies Propagated The Illusion of A Low Risk Investment Environment ¾
¾
They assigned high, investment grade ratings to opaque structured financial products and debt issued by highly leveraged companies Since the outbreak of the credit crisis, they have downgraded over $1.9 trillion of mortgage backed securities Rating Agency Downgrades: Mortgage Backed Securities(1) ($ billions) 1,000
739
800
841
600 400 200
237 85
0
Q3 2007 12
Q4 2007
(1) Source: Citigroup. September, 17 2008.
Q1 2008
Q2 2008
The Bottom Line Is That Systemic Leverage Rose To Unprecedented Heights ¾
Total U.S. Credit Market Debt Has Risen to 350% of GDP %
Total Credit Market Debt / U.S. GDP
350
(1)
Today
330 310 290 270
Great Depression
250 230 210 190 170 150 130 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 13
(1) Source: Ned Davis Research, 2008.
Warning Signs
14
Default Rates Started to Rise ¾
Default rates on certain types of subprime mortgages had risen to above 20% (vs. 6% at the beginning of 2005) Mortgage Default Rates(1)
15
(1) Source: Freddie Mac, March 27,2008.
The Market Prices of Mortgage Backed Securities Fell Precipitously ¾
Market prices of mortgage backed securities had fallen dramatically by the end of last summer Price Performance of Asset Backed Security Indexes(1)
16
(1) Source: BNP Paribas, September 15, 2008.
Investment Banks Couldn’t Syndicate High Yield LBO Debt ¾
Private equity deals started to fall apart as debt markets re-priced risk and rejected complex structures Large LBO Failures Sallie Mae ($25.5 billion) Huntsman ($10.6 billion) Affiliated Computer Services ($8.0 billion) Harman International ($8.2 billion) Alliance Data ($7.8 billion) Penn National Gaming ($6.1 billion) United Rentals ($4.0 billion) Acxiom ($2.9 billion)
17
Investment Funds Lost Billions Betting on Risky Credit Instruments ¾
Two of Bear Stearns’ flagship hedge funds collapsed in July 2007 The funds had invested $1.5 billion in subprime CDO’s These failures were followed by the collapse of Sowood Capital, a prominent $3 billion hedge fund
¾
Structured Investment Vehicles (SIVs) announced billions of dollars of losses and were liquidated
18
They had borrowed heavily in the short-term debt markets to fund purchases of CDOs and other longterm, risky debt instruments
Systemic Risk
19
Financial Institutions Announced Massive Losses On Mortgages and Credit Instruments ¾
Financial institutions have sustained over $500 billion dollars of write-downs since the credit crisis began
$ bil
The IMF expects that total financial losses will exceed those of any past crisis IMF Comparison of Losses Across Financial Crises(1) Minimum Anticipated Future Losses
1,000 800 600 400 200 0 US Savings and Loan Japan Banking Crisis Crisis (1986-95) (1990-99) 20
Asia Banking Crisis (1998-99)
(1)International Monetary Fund, “Global Financial Stability Report,” April 2008.
Credit Crisis (2007- ??? )
Several Systemically Important Institutions Have Failed in the US ¾
21
Victims of the credit crisis:
Bear Stearns (investment bank) ― Saved from bankruptcy by government backed sale to JP Morgan
Lehman Brothers (investment bank) ― Bankrupt
AIG (world’s largest insurance co.) ― Bailed out
Washington Mutual (6th largest US bank*) ― Assets seized by the government and sold to JP Morgan
Wachovia (3rd largest US bank*) ― Sold to Wells Fargo after an aborted bid by Citigroup
* By deposits
A Radical Policy Response Seeks To Prevent A Systemic Collapse ¾
Under the Troubled Asset Relief Plan (TARP), the Treasury Department is:
¾ ¾
The FDIC is guaranteeing certain types of bank debt and has increased deposit insurance to $250,000 The Federal Reserve has taken extraordinary steps:
22
Purchasing up to $250 billion in equity stakes in US financial institutions, including $20-25 billion stakes in Bank of America, Citigroup, and Wells Fargo and $10 billion stakes in Goldman Sachs and Morgan Stanley Purchasing up to $700 billion of financial sector assets
Allowed banks to post unconventional assets as collateral Begun purchasing commercial paper from corporations Extended a $50Bn credit line to money market funds Begun paying interest on bank reserves
Europe
23
The Credit Crisis Has Struck Europe With A Vengeance ¾
Europe’s economies are in many ways as vulnerable as America’s
Leverage levels are high, house prices are inflated, and financial institutions have suffered deep losses
UK Household Debt/Income (%)(1)
Bank Leverage: Europe vs. USA(1) (Assets/Equity) 38x
21x
Europe 24
Source: (1) Citibank, “A Downward Spiral.” 17 September 2008.
USA
Large European Financial Institutions Have Experienced Extreme Distress ¾
In the United Kingdom
¾
In Germany
¾
Hypo Real Estate ― Bailed out by the German government
In France & Belgium
25
RBS ― The British government is recapitalizing Europe’s largest bank by assets HBOS & Lloyds TSB ― The UK government is injecting capital into both banks (Britain’s 4th & 5th largest), having already engineered their merger Northern Rock and Bradford & Bingley ― Two of the UK’s largest mortgage lenders became insolvent and were nationalized
Fortis ― Europe’s 11th largest bank was sold off piecemeal and partly nationalized Dexia ― France and Belgium were forced to recapitalize Europe’s 16th largest bank
Other Systemically Important European Banks Are at Risk ¾
Many of Europe’s largest banks operate at very high leverage levels
One reason is that many of them have highly leveraged investment banking operations European Banks’ Leverage Ratio Compared With Citigroup(1)
Citigroup
26
Source: (1) Greed & Fear, 09 October 2008.
European Governments Have Been Forced To Take Radical Action
27
¾
European governments have pledged a total of $2.5 trillion to guarantee bank debt and purchase equity stakes in financial institutions
¾
Eurozone governments have agreed to guarantee all new bank debt issuance through 2009
¾
Ireland, Germany, and Denmark have guaranteed all consumer bank deposits
¾
European central banks are offering unlimited dollar funding to banks in order to unclog interbank lending
European Governments Have Been Forced To Take Radical Action ¾
28
Specific national policies include:
The UK Government is guaranteeing bank debt and injecting ₤50 billion into banks including RBS, HBOS, and Lloyds TSB
Germany is guaranteeing up to $544 billion of bank debt and plans to buy equity stakes worth up to $109 billion
France is creating a state fund to buy stakes in financial institutions and has guaranteed $435 billion of bank debt
Spain is guaranteeing up to $136 billion of new bank debt, has set up a facility to purchase equity stakes, and plans to buy up to $68 billion of bank assets
Iceland has nationalized its entire banking system and may borrow billions of dollars from Russia and the IMF
Source: Wall Street Journal, 14 October 2008.
Emerging Markets
29
Emerging Markets Have Posted Steep Stock Market Losses ¾
Heightened risk aversion, capital flight, and deteriorating economic growth prospects have produced dramatic equity price declines YTD Performance of EM Equity Markets(1)
120
100
S&P 500: (38.8%) India: (48.1%)
80
Asia: (52.2%)
60
30
MSCI Latin America
MSCI Eastern Europe
India (SENSEX)
US (S&P 500)
Source: (1) Bloomberg, 10 October 2008.
MSCI Emerging Asia
Sep-08
Sep-08
Aug-08
Aug-08
Jul-08
Jul-08
Jul-08
Jun-08
Jun-08
May-08
May-08
Apr-08
Apr-08
Mar-08
Mar-08
Feb-08
Feb-08
Jan-08
Jan-08
40
Jan-08
Lat. America: (60.9%) E. Europe: (62.2%)
The Credit Crisis Has Disrupted Capital Markets and Exposed Fiscal Weaknesses ¾
Regions and countries with major fiscal imbalances have been hit hard
¾
31
Many emerging markets rely on foreign capital inflows to finance large current account deficits They have funded domestic credit growth with foreign borrowing Some developing economies are heavily commodity dependant and will weaken as commodity prices fall
Capital flight is a major risk for these economies
Certain Emerging Markets Are Vulnerable ¾
¾
Emerging markets with high current account deficits and tight banking sector liquidity could experience full-blown financial crises Regions/Countries at risk include: Central & Eastern Europe ― The Baltic states, Bulgaria, Romania, Ukraine, and Hungary have large current account deficits and have experienced unrestrained credit growth Latin America ― Countries including Brazil, Peru, Argentina, and Venezuela could see their fiscal positions deteriorate if commodity prices fall further Pakistan ― The country’s credit ratings have been cut due to its deteriorating external liquidity situation and dwindling foreign reserves
32
Certain Emerging Markets Are Vulnerable ¾
Eastern European current account deficits and Latin American commodity dependency are key vulnerabilities Certain CEE countries will experience credit contractions, reduced investment, and slower growth Latin American governments may have to raise taxes or cut spending as commodity related revenues fall
CEE Current Account Deficits(1) (2007) 0% -5%
-4.9%
-10% -15%
8.7% 1.8%
-2.0% -5.0%
-18.2% -22.0% Bulgaria
33
2007 Actual 2007 Pro-forma 1.1%
1.7%
-13.7%
-20% -25%
-5.3%
Lat. Am. Fiscal Balances Pro-Forma for Commodity Prices at 10 Yr Avg.(2)
Baltic Romania Hungary United States States
-2.6%
-8.1% Argentina
Brazil
Chile
Sources: (1) Economist Intelligence Unit, 13 October 2008; (2) Morgan Stanley, 30 September 2008.
Peru
What About India? ¾
India has benefited from rapidly increasing capital inflows since 2000, but these are set to fall
Capital inflows funded investment and boosted GDP growth above its long-term sustainable rate Capital Inflows Received by India(1) $ billions
98
100 50 10
21
39
0 2000-2 Avg. 2003-5 Avg.
¾
2007
But India should prove relatively resilient due to growing domestic demand low reliance on exports
34
2006
Growth is likely to moderate to a more sustainable rate of ~6-7% (from a 3-year average of 9.3% as of March 2008)
Sources: (1) Morgan Stanley, 30 September 2008; (2) Carlyle Analysis.
What About China? ¾
Of the world’s major economies, China’s is best positioned to weather the storm Key reasons include: 1. China has amassed $1.8 trillion of foreign currency reserves as a result of its persistently high current account surpluses 2. The economy benefits from a very low level of leverage and low external debt ― debt levels for households and the government are only 13% and 33% of GDP, respectively 3. Domestic banks remain awash with liquidity as a result of deposit growth and reserve accumulation 4. The banking system in China operates on a conservative basis with low leverage levels and without securitization
35
Sources: (1) Morgan Stanley, 07 October 2008; (2) Carlyle Analysis.
Recession in The West Will Affect Chinese Growth Prospects Transmission mechanisms include: ¾
Trade
¾
Investment
¾
Western investors have supplied much of the capital that has been used to grow China’s companies
Opportunities for International Expansion
36
Western economies are key consumers of Chinese exports
Many of China’s most successful companies – such as Lenovo and Bank of China – are expanding abroad
But China Will Continue to Grow Rapidly ¾
24%
Domestic growth will offset weaker external demand
An increasing proportion of GDP derives from domestic demand
China’s growing middle class has rapidly increased its consumption of items like cars and electronics
Abating inflationary pressures will allow China’s central bank to further loosen monetary policy Chinese Retail Sales (% Change YoY)(1)
22% 20% 18% 16% 14% Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug08 08 08 08 08 08 08 07 07 08 07 07 07 07 07 37
(1) Source: China Statistics Bureau, August 2007.
The Middle East
38
The Middle East Is Likely To Prove Resilient ¾
The credit crisis is affecting the Middle East but not as much as other regions
¾
¾
Nevertheless, the credit crisis in the West has precipitated a regional liquidity contraction
Foreign banks in the region have stopped lending money
Regional stock markets have posted dramatic declines
Local banks are generally healthy
This cloud has a silver lining
39
The IMF forecasts only a slight moderation of GDP growth to 6.0% in 2009 (vs. 6.5% in 2008)
The credit down-cycle and falling food and energy prices are moderating inflationary pressures
Sources: IMF World Economic Outlook, October 2008; Emerging Markets Monitor, 6 October 2008
Oil Price Declines Are Significant But Not Disastrous ¾
Economic growth is being sustained mainly by non-oil sectors including construction, retail, transportation, and financial services Middle Eastern GDP Growth: Oil vs. Non-Oil Sectors (1) %
40
Source: IMF World Economic Outlook, October 2008
Oil Price Declines Are Significant But Not Disastrous ¾
Most government budgets and investment programs in the Middle East will remain intact unless oil falls below $50/barrel
¾
41
A prolonged drop below $50 is highly unlikely because global demand for oil continues to rise while supply is largely static
Middle Eastern governments have amassed huge reserve funds which they could deploy to support regional growth if the outlook darkens
Middle Eastern government saved 70% of their surplus oil revenues over the past five years
Sovereign wealth funds in the MENA region have over $1.5 trillion at their disposal
Sources: Monitor Group, “Sovereign Wealth Funds and the MENA Region,” 12 May 2008; Carlyle research & analysis.
The Current Situation
42
Central Banks Have Responded With Coordinated Global Rate Cuts ¾
On October 8th, 21 countries around the world simultaneously cut interest rates
The Federal Reserve cut the federal funds rate by 50 basis points to 1.50% October 8th: Key Interest Rate Cuts(1)
43
Source: (1) Financial Times, 08 October 2008.
Credit Market Stress Remains At Unprecedented Levels ¾
But global interest rate cuts have done nothing to encourage private sector lending
The spread between US Treasuries and the interbank lending rate remains at all time highs TED Spread: 3 month LIBOR – 3 month T-Bill(1)
44
Source: (1) BNP Paribas, 10 October 2008.
Global Equity Markets Have Crashed ¾
Global stock markets are testing multi-year lows
The MSCI World index has fallen by over 40% since its 2007 high MSCI AC World Index(1)
45
Source: (1) Greed & Fear, 09 October 2008.
Commodity Prices Have Retreated ¾
The price of oil has fallen by 40% since its peak in July 2008 Oil Price/Barrel Since January 1st (1) 150 140 130 120 110 100 90
Ja n-0 8 Ja n-0 8 Fe b-0 8 Fe b-0 8 Fe b-0 8 Ma r-0 8 Ma r-0 8 Ap r-0 8 Ap r-0 8 Ma y -0 8 Ma y -0 8 Ju n-0 8 Ju n-0 8 Ju l-0 8 Ju l-0 8 Au g -0 8 Au g -0 8 Au g -0 8 Se p -0 8 Se p -0 8 Oc t-0 8
80
46
Source: (1) Bloomberg, 10 October 2008.
Consumer Access to Credit Is Dwindling ¾
US Consumer credit fell by a record $7.9 billion in August
This was the first drop since 1998 and the largest monthly decline in history Monthly Net Increase in Consumer Credit Outstanding(1)
47
Source: (1) Greed & Fear, 09 October 2008.
The United States Is Falling Into Recession ¾
Unemployment rose to 6.1% in August from 5.7% in July
¾
Retail sales fell by 0.3% in August and were down 0.7% excluding automobile sales
¾
The main index of US manufacturing activity fell 13% in September
¾
The current level has only been seen before during full-blown recessions
US GDP growth is slowing significantly, and outright contraction is likely
48
The 1.1% surge in the unemployment rate over the past 4 months is the fastest in 22 years
Goldman Sachs forecasts US GDP growth of 1.5% in 2008 and -0.2% in 2009 (vs. 2.0% in 2007)
Much of the Rest of the World May Follow in America’s Footsteps ¾
Economists are ratcheting down global growth estimates Key factors likely to suppress growth: Decreased global liquidity Lower capital flows to emerging markets Reduced G-7 demand for imports Lower demand for commodities
¾
49
Key 2009 GDP growth forecasts* 2009E
2008E
2007A
Euroland
0.5%
1.1%
2.6%
United Kingdom Japan China
0.4% 0.5% 8.7%
1.0% 0.7% 9.8%
3.0% 2.1% 11.9%
Brazil
3.3%
5.6%
5.4%
* Goldman Sachs, 10 October 2008.
What’s Next?
50
Markets Will Recover From Recent Lows Investor panic had driven valuations to levels which were not warranted by fundamentals ¾ Monday’s rally may mark the beginning of a medium term rally ¾
¾
But this does not mean that equity markets won’t touch recent lows again in the future
51
It marked the largest ever one-day point gain for the Dow Jones Industrial Average and the largest percentage increase since 1933
Volatility may return as the deleveraging cycle continues and as a consumer recession sinks in
A Broader Recession Will Ensue ¾
85%
Tighter credit and lower house prices will severely depress consumption Home Price % Change vs. Previous Cycle (1) 66%
65%
70%
% of US Banks Tightening Consumer Credit (2)
50%
45% 25%
30%
20%
10%
5% -17%
-15%
20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08
-12%
-35% 1983-89 52
1990-95
-10%
1996-06
2007Present
Credit cards
Other consumer loans
Sources: (1) Zellman and Associates. September 2007; (2) The Federal Reserve Bank Officer Lending Survey, July 2008
The Deleveraging Process Will Be Unpleasant And Will Take Time ¾
Debt levels need to become more sustainable before an economic recovery can ensue %
Total Credit Market Debt / U.S. GDP
(1)
350 330 310 290 270 250 230 210 190 170 150 130 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 53
(1) Source: Ned Davis Research, 2008.
The Future Is Still Bright: Extraordinarily Positive Long-Term Macro Trends Exist ¾
¾
¾
Rapid growth of emerging markets
Billions of people will achieve relative prosperity
Opportunities for investment and development will abound
Technological innovation
Technology is evolving at a more rapid pace than at time in human history
This will increase productivity and living standards globally
Improvements in science and medical technology will directly benefit millions of people
Global peace and stability
54
The world is a more stable place than it has been for most of the past thousand years
Impact on Private Equity
55
Existing Investments Will Be Affected ¾
2000-2005
LBO activity boomed but leverage levels and acquisition multiples remained reasonable
Most deals done during this period will prove resilient
Global LBO Activity 2000-2005(1) $ Billions
291
300 247
250
100
110
102
Leverage Acquisition
8.0x
6.4
5.0x
65
4.0x
8.1 7.0
6.7
6.4 5.8
6.0x
142
50
4.2
4.1
4.6
4.8
5.3
4.0
3.0x
0 2000 56
9.0x
7.0x
200 150
Leverage vs. Acquisition Multiples(1) (of EBITDA)
2001
2002
2003
2004
2005
Sources: (1) Dealogic. (2) Standard & Poor’s.
2000
2001
2002
2003
2004
2005
Existing Investments Will Be Affected ¾
2006-1H 2007
A bubble developed in the private equity market
Debt and acquisition multiples rose above historical norms
Some companies bought during this period may experience financial difficulties Global LBO Activity(1)
$ billions
700 600 500 400 300 200 100 0
693
EBITDA Multiple
8.7x
6.0x 4.0x
160
2000-2005 Avg. 57
Leverage vs. Acquisition Multiples(1)
5.8x
8.0x
6.7x
6.0x
4.5x
4.0x
2.0x
2006-2007 Avg.
0.0x
10.0x
2.0x 0.0x 2000-2005 Avg.
2006-7 Avg.
2000-2005 Avg.
Sources: (1) Dealogic, Standard & Poor’s, Morgan Stanley Financial Sponsors Group, Carlyle Analysis.
2006-7 Avg.
Existing Investments Will Be Affected ¾
2H 2007
After the credit crisis hit, many deals met with difficulty
Investment banks could not syndicate LBO debt and a massive $389 billion debt backlog developed
Many deals were pulled; others were renegotiated on more favorable terms Busted Deals(1)
58
Restructured Deals(1)
Company
Value
Company
Value
Sallie Mae
$25.5 billion
ClearChannel
$27.3 billion
Huntsman
$10.6 billion
First Data
$26.3 billion
Harman Int.
$8.2 billion
Harrah's
$26.2 billion
ACS
$8.0 billion
Biomet
$11.4 billion
Alliance Data
$7.8 billion
HD Supply
$8.5 billion
Penn National
$6.1 billion
Thomson
$7.8 billion
Source: (1) Morgan Stanley Financial Sponsors Group.
New Private Equity Deals Look Different ¾
Private equity deals are smaller Average Deal Size (1)
$ Millions
600 519 500
Credit Crisis
422 400 300
294 251
200
171
155
143 97
100
134
0 2006 Q3 59
2006 Q4
Source: (1) Dealogic.
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
New Private Equity Deals Look Different ¾
Private equity deals involve more equity Average Equity Contribution (% of Purchase Price) (1)
40% 38% Credit Crisis
36% 34% 32% 30% 28% 26% 1997 60
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
1H08
2Q08
New Private Equity Deals Look Different ¾
Private equity deals involve less favorable debt terms Average Spread of Leveraged Buyout Loans (1) (vs. LIBOR)
bps
450
400 Credit Crisis
350
300
250 1997 61
1998
1999
2000
Source: (1) Standard & Poor’s.
2001
2002
2003
2004
2005
2006
2007
1H08
2Q08
New Private Equity Deals Look Different ¾
Private equity deals are fewer in number Number of Private Equity Deals
700
666
650 600
655 615
582
Credit Crisis
620
613
585
582 550
550 500
448
450
410 400 350 300 Q1 06 62
Q2 06
Q3 06
Source: (1) Standard & Poor’s.
Q4 06
Q1 07
Q2 07
Q3 07
Q4 07
Q1 08
Q2 08
Q3 08
New Private Equity Deals Look Different ¾
Private equity deals are less debt-dependant Minority Investment by Financial Sponsors (1)
Minority Investments ($ billions)
25
24
35%
% of Total PE Deal Volume Minority Investments
20
30%
15
15 10
% of Total PE Deal Volume
25%
16
20%
13 10
10
10
10
10
8
7
10%
5
5%
0
0% Q1 06
63
15%
Q2 06
Source: (1) Dealogic.
Q3 06
Q4 06
Q1 07
Q2 07
Q3 07
Q4 07
Q1 08
Q2 08
Q3 08
New Private Equity Deals Look Different ¾
More private equity firms are investing alongside corporate partners or sovereign wealth funds
¾
Holding periods will rise as private equity firms spend more time improving portfolio companies’ operational performance
64
Recent examples include Blackstone and NBC Universal’s $3.5 billion joint acquisition of the Weather Channel
Many exits will be delayed until the financial crisis subsides
Source: (1) Dealogic.
Private Equity Returns May Rise
Vintage Year IRR (%)
35
Private equity deals done during periods of economic difficulty tend to outperform U.S. Buyout Funds - Vintage Year Returns
30
30
25
25
20
20
15
15
10
10
5
5
0
0
-5
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000² 2001 2002 2003 2004 Median
65
35
Upper Quartile
Source: (1) Morgan Stanley Financial Sponsors Group.
5-Year Forward-Rolling S&P 500¹
-5
S&P 500 Annualized Return (%)
¾
Private Equity Trends
66
Several Key Trends Will Affect The Private Equity Industry
67
¾
Fewer lenders will provide debt to fund acquisitions
¾
Private equity firms will face less competition from investment & commercial banks
¾
Distributions to limited partners will fall in the medium term
¾
Decreased global liquidity will result in reduced commitments to new private equity funds
¾
There will be more co-investment opportunities
¾
There will be fewer PE commitments from high net worth individuals
¾
The terms of private equity partnerships may change
¾
Public perceptions of the PE industry will improve
Four Big Questions Confront The Industry
68
1.
Will governments intensify the regulation of the private equity industry?
2.
Will tax rates on private equity distributions rise?
3.
How will the industry’s public image evolve?
4.
Can the basic private equity business model still work?
Opportunity & Challenge
69
Private Equity Now Has Its Greatest Opportunity And Its Greatest Challenge ¾
70
Opportunity: To use its capital and expertise to save companies and turn them around
An enormous number of companies will now need fresh capital ― private equity has the necessary capital
Low prices can yield attractive returns ― perhaps the best ever
Private Equity Now Has Its Greatest Opportunity And Its Greatest Challenge ¾
71
Challenge: Overcoming the widespread conception that private equity firms are short term investors
The industry needs to recognize that turnarounds will not be easy
Private equity firms will be operating under an even greater level of public scrutiny
Maintaining investor confidence will be critical
The Opportunity And The Challenge Are Particularly Great In Financial Services
72
¾
Opportunity: To help strengthen financial institutions around the world, often working closely with governments in this endeavor
¾
Challenge: To restore confidence in financial institutions during times of unprecedented market disruption
Private Equity Now Has Its Greatest Opportunity And Its Greatest Challenge ¾
73
Bottom Line: This could well turn out to be private equity's finest hour ― if the industry moves carefully and skillfully to help with the global economic turnaround, partnering at times with corporations, sovereign wealth funds, and governments
Private Equity in the MENA Region
74
Key Predictions
75
¾
Private equity activity may moderate but will remain strong
¾
Demand for investment capital from companies in the region will rise
¾
Local private equity firms will be the most active investors
¾
Some new global players will enter the market
¾
Minority state transactions will predominate
¾
Investment opportunities will be better than before
¾
Sovereign wealth funds in the region will focus more of their attention on the region
Lower Stock Market Valuations Could Be A Boon For Private Equity Investors ¾
Regional stock markets have fallen because they were previously over-inflated
Investors had pushed up valuations to unsustainable levels
Many of them have withdrawn capital because the credit crisis has increased risk aversion and demand for cash
GCC Stock Market Performance
76
GCC P/E Ratios
Lower Stock Market Valuations Could Be A Boon For Private Equity Investors ¾
Private equity investors can now buy assets at prices that are very attractive from a long-term perspective
77
The MENA region’s robust growth prospects and insulation from the credit crisis make it one of most attractive areas in the world for private equity investment
Conclusions
78
Key Conclusions
79
¾
The world of private equity will change – for many years – as a result of the credit crisis and the unfolding economic slowdown
¾
The MENA region will be affected by changes in the United States and Europe
¾
The appeal of the MENA region will increase ― although investment activity may moderate, it will be higher than in many other regions
The Impact of the Financial Services Meltdown on The Global Economy And The Private Equity Industry
David Rubenstein, Co-Founder Super Return Dubai October 15, 2008 80
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