The peak purchase prices private equity firms secured immediately prior to the financial crisis have left many firms stuck with poor exit options after portfolio valuations plunged in the aftermath of the crisis. The decrease in portfolio valuations resulted in increased holding times across the private equity industry as profitable exit options disappeared. ((Jonathan Parker, Private Equity-Backed Portfolio Company Holding Periods, Private Equity Spotlight (Preqin, New York, N.Y.), May 2013, at 10, 10, https://www.preqin.com/docs/newsletters/pe/Preqin_PESL_May_2013_Holding_Periods.pdf.)) For example, deals in the large cap space of $1 billion or more saw the most dramatic increase in holding periods: in 2008 the average holding period was 2.1 years, in 2013, that time has increased to 6.1 years as funds are still being forced to hold onto companies they purchased during the buyout boom immediately preceding the crisis. ((Id. at 11.)) Some worry that a shakeout brewing since private equity firms’ “unprecedented $702 billion [attracted] from investors from 2006 to 2008” is around the corner. ((David Carey, Buyout-Boom Shakeout Seen Leaving One in Four to Starve, Bloomberg L.P. (Feb. 12, 2013, 12:50 PM), http://www.bloomberg.com/news/2013-02-12/buyout-boom-shakeout-seen-leaving-one-in-four-to-starve.html.)) This trend has led to firms having an enormous amount — more than $100 billion — of yet to be invested money that must be invested by the end of 2013 when most five year investment periods will run out. ((Id.)) The downturn in exit value and activity, combined with the presence of “dry powder,” means that fund managers are struggling to match contributions and once these investment periods run out many worry that they will not be able to attract investments to replenish their funds. ((Id.)) One consequence to the impending shakeout is that many, including Carlyle Group LP co-founder David Rubenstein and Blackstone Group LP President Tony James, are managing investor expectations by warning of lower returns from buyouts in the future. ((Id.))
However, there is some encouraging data. Since 2011, exit activity has been on the rise, meaning, hopefully, fundraising and capital movement in private equity will be as well. ((Parker, supra note 1, at 11.)) As evidence, 2011 saw the median exit valuation hit a high not seen since the crisis. ((Private Equity Exit Activity, Private Equity Exits Report – 2012 Annual Addition (PitchBook Data, Inc., Seattle, Wash. & Grant Thornton LLP, Chicago, Ill.), 2012, at 1, 4, http://www.grantthornton.com/staticfiles/GTCom/Private%20equity/Private%20Equity%20Exits%20Report/GT_Exits_Report_2011_2H-Final.pdf.))
A recent deal by a well-known industry player, is reminding, and perhaps amplifying the encouragement of some in the industry, that private equity firms are still capable of circling back to their old tricks. In May 2012, funds controlled by Apollo Global Management (“Apollo”), and other investors, acquired oil and gas producer EP Energy for nearly $7.2 billion. ((Apollo Global Management Completes Acquisition of EP Energy, Business Wire, May 24, 2012, http://www.businesswire.com/news/home/20120524005882/en/Apollo-Global-Management-Completes-Acquisition-EP-Energy.)) Now, less than 18 months after the takeover, Apollo is taking EP Energy public and must have investors smiling at the prospect of a twofold return. ((Christopher Swann, Apollo’s Energy I.P.O. Gives New Life to Quick Flips, N.Y. Times (September 30, 2013, 2:12 PM), http://dealbook.nytimes.com/2013/09/30/apollos-energy-i-p-o-gives-new-life-to-quick-flips/.)) The potential valuation of EP Energy at $11.3 billion based on forecast 2013 earnings before interest, taxes, depreciation, and amortization means that Apollo would double its $3.3 billion equity investment — all the more impressive given the 18 month turnaround. ((Id.))
Turnarounds comparable to Apollo’s are what gave rise to the industry term of a “quick flip,” which refers to deals when a private equity firm buys and sells a company generally within a year, though the 18 months here, certainly qualifies as a quick flip given current holding periods. Some investors and the public at large are skeptical of these sales because “a quick flip is seen by many on Wall Street as a way for a buyout shop to use frothy financing markets to make a quick buck, regardless of whether the acquired company is ready to be sold.” ((Michael Flaherty, Refco Woes Puts Spotlight on “Quick Flips,” Reuters, Oct. 13, 2005, available at http://mba.tuck.dartmouth.edu/pecenter/news/news_articles/reuters_10_13_05.html.)) But, if done correctly and profitably, most investors like them because it allows for a twofold return. First, once profits stabilize or increase, the level of debt used to purchase the company is brought down, thus generally providing a significant dividend — $337 million in Apollo’s case ((Swann, supra note 10.) — to the fund and investors. Second, investors can still expect a multiple of return on exit, here an I.P.O, with the presumably lower levels of debt increasing that number, provided Apollo is not playing into quick flip critics’ arguments and jumping the gun. While EP Energy is still relatively debt heavy, Apollo did restructure several aspects of the business to be more responsible including divesting risky assets in Egypt and shifting the production “focus . . . away from cheaper gas to more lucrative oil.” ((Id.)) Time, and the markets, will illuminate EP Energy’s readiness for an I.P.O. and the responsibility of Apollo’s quick flip.
The private equity industry is certain to undergo some serious changes in the next few years, but firms like Apollo are proving that there are still firms out there that can bring a company’s financial and business operations up to par and deliver returns to investors in a short period of time, or at least that’s what they are saying.