Where Private Equity Is Going in 2014

 | Dec 27, 2013 | 12:30 PM EST
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As we head into the final weekend of the year, I want to spend just a little more time talking about what private-equity funds are doing with their cash. For asset-based, deep-value investors, adopting a private-equity mindset is critical for long-term success. Studying what these funds are doing is instructive and turns up ideas and insights that can be used to make money.

Most investors would be better off reading private-equity-related sites such as PEHub and Dealbook, instead of the trading and hot-stock sites that most seem to favor.

One of the areas attracting a lot of attention from private-equity funds right now is the energy patch. Warburg Pincus is currently said to be raising a $3 billion energy-focused fund. It will join other private-equity giants such as Carlyle Group (CG) and KKR (KKR) that already have energy-related funds to take advantage of low asset values in the sector. Blackstone (BX) is also raising a new $2.5 billion energy fund as we go into 2014.

Oil-and-gas-related companies, especially the small and mid-market companies, are very cheap and have been all year. There are tremendous opportunities in companies such as WPX Energy (WPX) and Swift Energy (SFY) for investors who have a private-equity mindset and who are willing to hold these stocks for five to seven years.

Europe is also attracting the attention of private-equity investors. Firms such as Bain Capital and KKT have announced new funds that are focused on European markets. Marc Lasrey's Avenue Capital is also raising money to make loans to small and midsized companies in the Old World that will be structured as private-equity vehicles. Oaktree Capital (OAK) has already raised $750 million for the same purpose.

Europe is struggling toward an economic recovery, and there are still a lot of undervalued and mispriced companies throughout the region. Long-term private equity-money is anxious to benefit from the eventual full recovery a few years down the road.

Another area attracting attention from private-equity Investors is special situations, which have been very hot the past few years. Several firms, including KRS Capital, Oaktree and Carlyle, are raising special-situation funds to invest in distressed debt and turnarounds. It is a bit harder for individuals to mimic the distressed-debt portion of these funds, as that is now a game strictly for the big boys. Those who are interested in these situations might want to consider using a fund such as Avenue Capital's Income Credit Strategy (ACP) or Third Avenue's Focused Credit Funds (TFCVX).

When I first started in the finance world, if you had a good idea where you stood in the capital structure and the value of the assets, there was pretty easy money in the distressed game. That has changed over the years, and today you need a fleet of attorneys and CPAs to play the game, so it is best left to the specialists.

The turnaround portion of the special-situations segment is a little easier for us to replicate. I write about longshots and turnarounds on a pretty regular basis, and even after the recent massive run-up in stock prices, there are opportunities. ACCO Brands (ACCO) and Asta Funding (ASFI) offer returns of many times the current stock price if the long-term turnarounds are successful.

Financial services firms that bear watching include the small banks that make up the "Trade of the Decade." Private-equity firms such as Corsair Capital, Stonepoint Capital, Patriot Financial and Carpenter Funds have been active in this space the past few years, and I expect them to continue to do so. Banks are still very cheap on a price-to-book basis, and the potential long-term returns in this space are enormous. Patient investors should pay very close attention to what the private-equity and activist investors are doing in bank and financial-services stocks and ride their coattails to profit.

Private-equity investors are finding pockets of value in which to get money to work. Keep in mind that they have done a lot more selling than buying this year, and they are holding lots of cash right now. Investors need to think in terms of years rather than weeks or months and use the private-equity mindset to earn the types of profits that have continually made private equity one of the highest-performing asset classes for several decades.

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