The mood among private equity companies is sombre - which is hardly surprising.
In SA, the barometer of sentiment is measured every six months by professional services firm Deloitte, which surveys about 400 private equity practitioners under its "Private Equity Confidence Index".
According to Deloitte corporate finance manager Greg Benjamin, there is an air of uncertainty in the market. "The real questions people are focusing on now are will it get worse, and how long before there is a recovery."
Overall, 40% of private equity firms surveyed told Deloitte they expected the economic climate to deteriorate, while 33% expected it to remain as it was and 27% expected it to improve.
Surprisingly, Deloitte head of private equity Sean McPhee says this actually heralds an improvement in sentiment from the last survey. "This shows that many people believe the private equity market has already turned the corner. In October last year, 73% of those surveyed thought it was going to decline."
An overwhelming majority (80%) of people believe that the prices to buy into target firms (entry multiples) will drop, as will prices that private equity firms will be able to get when they sell (the exit multiple). Of course, this represents a big buying opportunity and is the main reason why 51% expect to invest all their funds in the next two years, and 62% say they'll raise new funds in the next year.
But is this confidence misplaced? Can these private equity firms actually raise these funds?
The private equity firms realise it won't be as easy to raise cash as it was two years ago: 76% say they expect to encounter some difficulty in raising these funds.
In the past, SA private equity companies have raised funds from the local market, as well the UK, Europe, Canada and the US. But with international markets suffering liquidity shortages, private equity is looking to the east to bridge the funding gap.
Though 37% of those surveyed expect to raise most of their capital from SA, 29% still favour the US and 20% are looking at Europe. The important change, however, is that 14% say they are now looking to the east to raise cash. "Sovereign wealth funds would be the target, but this comes with its own challenges," says McPhee. "Most of the time, raising funds is done through existing relationships. But when it comes to the Middle East and Asia, there are language and cultural issues that make it far more complex."
But Benjamin asks: "Would you, as an investor, rather put money in China - which is still expected to have GDP growth of about 7% - or into SA, where some experts have said the growth rate could drop as low as 1% or less?"
The competition for capital is fiercer than ever, and SA private equity funds may be too glib in expecting to easily raise cash from Asia or petrodollars from the Middle East.
Locally, McPhee says banks, insurance companies and corporate entities aren't providing the level of funding for private equity that they once did, and this shortfall is expected to be filled by new sources, including private individuals and pension funds.
But the nature of deals has changed too. Whereas in 2006, at the height of the private equity craze, buyers would put only 40% equity into a transaction and 60% debt, this has mutated. Now, private equity firms are having to plough in more equity and less debt. At the moment, this equity:debt ratio is about 70:30 for the average deal.
As a consequence of the inability to "leverage up" these deals, this means the private equity deals you'll see in the next year are likely to be a lot smaller than in the recent past.
Overall, four-fifths of the 400 private equity practitioners surveyed by Deloitte believe the deal size will fall.
"Deals will require more equity than before and we expect to see more collaboration between private equity and corporates co-investing in opportunities," says McPhee.
The good thing for SA private equity funds is that competition for assets has decreased, as the large international private equity firms that arrived in SA amid such fanfare in 2005 have drastically scaled back their involvement.
While Bain Capital's R25bn purchase of Edcon was a high watermark of SA private equity deals two years ago, it's likely to remain the benchmark for many years to come.
"All the evidence suggests that the size and volume of transactions will decrease in the short term," says Benjamin. He says this drop is caused by lower debt-to-capital ratios, along with a general decline in asset prices. Transaction volumes will also drop because of the decrease in prices, and less competition for the assets.
This illustrates that the game has changed for investors - a metamorphosis that can also be seen in how funds are managing the companies they bought during the frenzy earlier this decade.
Rather than simply plotting deals, clinching a handshake and moving on to the next big deal, private equity investors have turned their attention back to the operations of the companies they bought.
Of the investors, 39% of the private equity firms say they'll spend most of their time on "portfolio management". This is essentially looking at improving the operations of those firms - a sharp climb from the 25% who'd placed priority on this aspect of their business two years ago.
And in 2007, 40% of private equity companies said their main priority was "looking for new investments" - now this has fallen to 25%.
But for those looking for new investments, where are they likely to find them? Which are the vogue sectors in which to invest?
In 2007, manufacturing and services sectors were hot favourites, and this ardour continues, according to Deloitte. This year, there is also a new focus on the health-care industry.
For the first time, Deloitte's survey looked at skills in SA's private equity industry. A fascinating finding is that four-fifths of firms expect the "skills pool" to increase in SA, probably due to overseas retrenchments that may make expatriates return home. And it won't just be financial whizz kids who are in demand, as portfolio managers and MBA graduates are likely to be hot property for private equity funds. But the market rollercoaster has also altered the investment horizons of private equity firms.
When it comes to exit strategies, the Deloitte survey confirmed that private equity companies don't want to sell out in such a depressed market, so 80% plan to delay their exit beyond the next 12 months. "Private equity companies have the sort of flexibility that allows them to delay selling," says McPhee.
In all, Deloitte's barometer of the industry's health doesn't paint a flattering picture of the private equity landscape. So it probably comes as a surprise that investors are still betting on private equity to bring home the bacon. Of those surveyed by Deloitte, 83% believe that the returns they'll get from private equity will outperform the relevant index on the JSE. McPhee says this illustrates that "investors believe strongly that private equity has a tried-and-tested business model".
Despite the view that private equity is "higher risk", 26% of investors polled by Deloitte planned to increase their allocation of cash towards private equity, while 57% said they'd maintain their current level of investment in this asset class. With such confidence vested in their abilities, it's little wonder that private equity firms are treating this responsibility with some caution.
Far from the devil-may-care reputation often ascribed to private equity funds, McPhee says SA's private equity hotshots are playing it cautiously, waiting for some catalyst to show that it's "time to buy". "A lot of people are assessing their opportunities, but few are actually committing funds. Capital is quite precious right now, so many people are asking themselves: 'Can I get this asset cheaper tomorrow?'"
