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Does Warren Buffett Have a Private Equity Problem?

- By Rupert Hargreaves

Warren Buffett (Trades, Portfolio) has a problem: the private equity industry.

According to several estimates, the private equity industry is now sitting on so-called dry powder (funds raised but not yet deployed into deals) of $1.2 trillion to $2 trillion.

This is a tremendous amount of money and shows the amount of conviction investment managers generally have in the private equity space. Having so much money, however, is not necessarily a good thing for the industry because while private equity funds now have more money than ever to spend, they have to pay increasingly high prices to acquire companies.

The Financial Times recently pointed to the example of Scout24, a German online advertising group that was recently reacquired by the buyout firm that floated it in 2015 for a 50% premium. Overall, in 2018, the median multiple of private equity deals was 11.6 times earnings before interest, taxes, depreciation and amortization, down slightly year-over-year, but still near all-time highs of 12.9 times Ebitda.

A $2 trillion problem

Private equity's vast dry powder reserve and willingness to do deals at eye-watering valuations is a thorn in Buffett's side. With more than $100 billion in cash to deploy, Buffett has been hunting for his next big kill for several years now, but no deals have been forthcoming.

I'm not saying Buffett's lack of activity is a direct result of the booming private equity market, but I think it has almost certainly pushed valuations of private businesses higher across the board, reducing the number of opportunities available to the Oracle of Omaha.

He commented briefly on the private equity industry and the impact it has on Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) at the 2005 annual meeting of shareholders. When one shareholder asked if private equity and hedge funds were causing trouble, Buffett replied:

"There's no doubt about it that there is far more money looking at deals now than five years ago, and they're willing to pay out more for the good but mundane businesses that we've been successful at buying in the past."

He went on to say a lot of these businesses were willing to buy things Berkshire is not, and "that's a source of distress to us."

"And there are a lot of companies that are being sold, that are being sold to someone who's buying them to resell in a fairly short period of time. We can't compete in that field and that's, you know, that's a source of distress to us. But that's the way it is."

Buffett, however, was confident this trend would not last forever and, sooner or later, an attractive opportunity would present itself:

"We will -- it won't go on forever, in our view. We still occasionally, as this deal I mentioned to you, the party on the other side and we just -- we made a deal that did not go through an auction process. And we see that occasionally, but we don't see it anything like we saw it four or five years ago.

So, in terms of the near-term outlook for Berkshire, in terms of doing what it's important that we do, do successfully, which is buy businesses and keep adding to this collection...And we do find it extraordinary, both Charlie and I have over the decades, just how fast things can change.

There have been at least three times, maybe more, where it's looked to me in my own career, where it looked like there was so much money sloshing around that it would be impossible to do intelligent things with money. And I actually terminated a partnership back at the end of 1969 because I felt that that the money was coming out, you know, of the woodwork. There were all kinds of people that wanted to use it and compete, and I just didn't feel we could do intelligent things.

Within four years, I saw the greatest opportunities that I've ever seen in my lifetime. And we've had several experiences like that."

Several years later, Berkshire was rewarded for its patience when the financial crisis exploded and Buffett was able to deploy billions into new deals. I do not doubt we will see another market crash at some point, but until then, Buffett's elephant drought is likely to persist.

Disclosure: The author owns shares of Berkshire Hathaway.

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This article first appeared on GuruFocus.