3i, Europe's largest listed private equity group, said last week the value of its 50 largest investments fell 21 per cent in the fourth quarter of 2008, while EQT Partners, the Nordic buy-out group, wrote down its EQT Fund IV by 50 per cent.
The moves are likely to be the start of an avalanche of downgrades as the private equity industry, which made only tiny writedowns in the June and September quarters, catches up with reality in the public markets.
"Private equity is easily lagging 12 months behind the public markets. The whole industry will take a substantial valuation hit in [the] December [figures]," said Hanspeter Bader, head of private equity at Unigestion, a Swiss investment house.
Based on tumbling price/earnings multiples in comparable public equity markets, Mr Bader said: "The buy-out industry will easily show valuation declines of 25-35 per cent in December against the September accounts.
"What is worrying me about that is that it is based on often quite stable earnings and revenue in 2008 for the underlying companies. In 2009, if the recession goes on, we will have the operational impact of the crisis on many public and private companies. Revenue and earnings will come down and the groups will be forced to value their portfolio holdings still on low multiples but also with lower earnings.
"December writedowns are still not the end. We are rather at the beginning of the valuation correction than at the end."
Jon Moulton, chairman of Alchemy Partners, the private equity group, said of two US buy-out firms he met last week: "Just in the last quarter the writedowns will be in excess of 25 per cent. They are two really big investors and the pain is very, very substantial."
Tim Jones, partner at Coller Capital, a secondaries house, also forecast two rounds of writedowns.
"Anecdotally, writedowns will be 40 per cent [for the fourth quarter]. Investors will be hoping that that is it, but my sneaking suspicion is there will be a second leg that is more earnings related," said Mr Jones, who said he feared funds focused on the largest buy-outs, which tended to use the most debt and pay the highest multiples, would suffer disproportionately.
Mr Moulton argued that, with many buy-outs struck with 40 per cent equity and 60 per cent debt, and many public markets down 40 per cent, the equity may be essentially worthless.
"The deals done between 2005 and mid-2007 were half of the private equity invested in all of history and it is a dreadful crop. In most of these deals the equity is a high priced way out-of-the-money option," he said.
A Europe-wide survey conducted by Jefferies, a New York investment bank, found private equity firms remain more optimistic about the performance of their portfolio companies than do their creditor banks.
Half of buy-out houses expect a maximum earnings fall of 10 per cent, with a fifth forecasting steady or rising revenues; almost a quarter of banks expect earnings falls of at least 30 per cent.
And some are critical of the industry's slowness in recognising asset downgrades, which would trigger falls in management fees.
London listed funds of private equity funds have actually raised their net asset value by 19 per cent over the past year, according to data from Winterflood Securities, while discounts on the underlying funds have risen to 72 per cent, suggesting investors believe published NAV figures are almost meaningless.
"If some groups realise now their equity might be worth nothing, then it's questionable why these adjustments did not happen in June or September," said Mr Bader.
