Geoff Cutmore - Morning Thoughts

This Is Private Equity's Golden Age

Geoff Cutmore

The above were the words of Henry Kravis, recently celebrating the success of the private equity industry. Kravis and his peers are in the headlines like never before, the cost of capital below the earnings yield of target companies is providing a powerful dynamic for the deals to continue.

Alchemy Partners' Jon Moulton, our guest host on "Squawk Box Europe" this morning, doesn't disagree, but expressed a note of caution: with interest rates rising and the cost of deals being stretched beyond 10-times earnings before interest, taxation, depreciation and amortization (EBITDA), the math of servicing the debt created in the deal is starting to look less attractive.

The tipping point still hasn't been reached, but the pincer of higher rates and stretched prices is going to slow the deal flow. Before we get to that point, there is sure to be a whole lot more hand wringing about the taxes paid, transparency in deals and treatment of pension funds. As Moulton noted, there seems to be some confusion within the industry itself about how it is meeting the broadsides from politicians and unions around Europe.

He called much of the criticism the politics of envy, driven by the super profits some deals have created. But it will not be easy to deflect pressure for action against the industry when there is criticism from within. SVG Capital Chairman Nicholas Ferguson's attack on the tax advantages has perplexed his peers. There will soon be a parliamentary committee meeting looking at the way the industry operates, such comments will only raise the temperature ahead of the session and expectations that tax rules are going to change.

Without getting too detailed, current rules mean an effective rate of 10% on profits after several years, as against the standard U.K. rate of capital gains of 40%.

Moulton doesn’t welcome changes, but expects they will come as momentum builds to extract more money from the industry. He warns the U.K. government in particular to be aware the private equity firms can move their domicile outside Britain to avoid additional taxes, should they be levied.

We will be reporting on the G8 meeting over the next few days -- private equity has even made it onto the agenda of this political talking shop. I doubt, however, it will grab the headlines against the backdrop of deteriorating relations between Russia and the U.S. Making money is one thing. Having nuclear missiles re-targeted at Europe is quite another.