Is smooth sailing over for private equity?

What does it mean when private-equity groups - some of the savviest investors on Wall Street - want to give you the opportunity to buy shares in their enterprise?

Some see it as a chance to make the kind of investment returns that bring visions of yachts bobbing off St Tropez. Or it may mean that the insiders at these companies think it will be harder to make money in the future and want to start cashing out now.

Either way, signs are appearing that private-equity groups may be having difficulty making deals, and how they conduct business is starting to change.

So far this year, the number of mergers and acquisitions has exceeded $2 trillion, up 57 per cent compared with the same period last year. "But we were up 67 per cent through the middle of May," says Sam Stovall, chief investment strategist at Standard & Poor's in New York. "One reason could be these deals are becoming more costly, and that has resulted in deals not getting done."

Rising rates

The deals are getting more costly because long-term interest rates are rising. "The private-equity companies borrow money in huge amounts," says Axel Merk of Merk Investments in Palo Alto, California. "As rates move higher, the deals they do become less attractive."

At the same time, lenders have become more selective after the subprime mortgage market - which offers mortgages to lower-quality lenders - had large losses. "There has been a reprising of risk," says John Mousseau, vice president and portfolio manager at Cumberland Advisors in Vineland, New Jersey.

The risk of investing in private-equity funds and hedge funds was the subject of a letter written to the chairman of the Securities and Exchange Commission by Representatives Dennis Kucinich of Ohio and Henry Waxman of California.

"The value of public investors' interests in Blackstone LP would be tied to the performance of the underlying hedge and private equity funds, which have not been considered suitable investments for the general public because of their high risks and speculative nature," wrote the two congressmen, who urged the SEC to delay the Blackstone initial public offering, which took place on June 22.

Congress may also look into the tax rates paid by private-equity groups. The companies, which are set up as partnerships, have been paying taxes at a 15 per cent capital-gains rate, according to reports. But they compete against firms such as Goldman Sachs, whose tax rate can be as high as 35 per cent. Key Democratic lawmakers are considering the opportunity to raise new revenue to pay for other programmes.

Blackstone and any other private-equity groups going public, traditionally very reticent to talk to the media, will also have to change the way they communicate, says Davia Temin, CEO of Temin and Co, a strategic-marketing firm in New York.

"They have not had to divulge a lot of information about themselves," she says. "They probably know all the rules. They just haven't been doing them."

Diversification

Considering these changes, why go public? Diversification of personal assets might be one reason, says Clifford Smith Jr, professor of finance and econ-omics at the University of Rochester's Simon Graduate School of Business. "It frees up personal funds," he says. "Here's a way to make sure if things don't look as rosy in the future, I have other irons in the fire."

According to The Wall Street Journal, Blackstone's CEO Stephen Schwarzman raised more than $900 million, and co-founder Peter Peterson collected $1.9 billion in the offering. Schwarzman will still own more than $7 billion of the company's stock and Peterson $1.35 billion, according to the Journal.

But others think it might be an indication that the era of large returns on private equity is ending. "If you're not at the top, you are approaching it," says Mousseau of Cumberland Advisors. "The smart money is getting out on the equity side."