Dec 4, 2007

John W. Rogers Jr.on the role of private equity in the credit bubble

Jeremy Grantham, head of the well-respected investment firm GMO, projected in his last quarterly letter that in just five years, half of today's hedge funds and a significant number of private equity firms will tank.

Private equity funds bear some responsibility for the enormous leverage that our entire financial system has taken on. The supersize deals they make involve scary debt loads. The multiples are rich, as much as 16 times operating income (Ebitda). Not long ago a fair price for a solid business was 10 to 12 times. The higher prices are worrisome given the large fraction of the purchase price that is borrowed. And until very recently many lenders have been blasé about excess leverage. With the huge fees to be earned, debt providers were only too pleased to oblige. Now they aren't so happy with $350 billion in buyout debt sitting on their books and no takers.

In my view we are only in the early innings of a significant market correction led by the finance sector. When financial firms struggle, they have a big effect on the broader economy, from consumer loans to initial offerings to mergers and acquisitions. A real recovery is going to take a while.

~ John W. Rogers Jr., chairman and CEO, Ariel Capital Management, "Defensive Moves," Forbes, October 29, 2007

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