At the annual meeting of shareholders this year, Warren Buffett told Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) shareholders that the growing pile of cash on its balance sheet could become a problem if he can’t find a way to put it to work. “There’s no way I can come back here three years from now and tell you that we hold $150 billion or so in cash or more, and we think we’re doing something brilliant by doing it,” he said.
Berkshire Hathaway isn’t the only investor swimming in cash to do deals. Many of the world’s largest private equity firms and alternative asset managers are awash in so-called “dry powder,” which includes cash or commitments from investors that they will have to deploy in the coming years.
Record amounts of cash on the sidelines
In all, leading private equity and debt investors have more than $200 billion of capital that they will have to deploy if they want the opportunity to collect outsize fees on the balances (they do!).
Given many of these managers leverage their investments with borrowed money, the actual dollar amount of deals they have to do may be several times larger than their surpluses of cash and commitments.
Blackstone Group (NYSE:BX)
Apollo Management (NYSE:APO)
KKR & Co. (NYSE:KKR)
Oaktree Capital Group (NYSE:OAK)
Charlie Munger suggested that Berkshire could do a deal as large as $150 billion, funded with its $80 billion of excess cash and a helping of debt. Blackstone, Apollo, and KKR have the most capital available for investment in their private equity and real estate funds, which use leverage through the ordinary course of business. Given this, it’s not out of the realm of possibility that between them, they may need to acquire businesses and assets worth half a trillion dollars or more to put all of their money to work.
Smaller shops are swamped with cash, too
Though Blackstone, Apollo, and KKR may be the biggest private equity managers, they certainly aren’t the only companies in the business. According to Bloomberg, private equity managers large and small collectively had $963 billion of cash and commitments to put to work buying assets. Buyout funds alone — those that have a mandate to buy companies in part or in whole — had $555 billion of dry powder in May 2017, according to Preqin.
The only thing growing faster than the amount of equity capital available for purchasing businesses is the amount of debt capital sitting around to finance large transactions.
This presents a problem for Berkshire, just as it does all other investors. More money chasing the same number of deals means it’s less likely for Berkshire to snag a bargain on a big acquisition. Just last month, Berkshire lost out on a $9 billion utility deal thanks to a higher bid from an activist investor. For his part, Buffett said he wouldn’t budge from his price — a promise kept — but it means Berkshire’s cash pile will only continue to grow.
Bargains going extinct
Some have taken the extreme view, believing that a surplus of cash makes it less likely that deal makers will be able to put money to work on attractive terms, if at all. What if distressed debt, which has long been Oaktree Capital Group’s specialty, simply dries up? With so much cash on the sidelines, just how far can asset prices decline before catching a bid?
Howard Marks, Oaktree’s founder, doesn’t see it so simply, writing in memos that the availability of liquidity doesn’t necessarily lead to stable prices. It’s not just about how much cash is sitting on the sidelines, but how willing investors are to risk the capital they have. Putting money to work when asset prices are falling is a very hard thing to do, as anyone can attest. No one wants to be early when prices are heading lower.
To be sure, private equity managers and alternative managers had a then-record amount of cash in 2008, which didn’t stop asset prices from plunging. Oaktree raised its largest-ever distressed debt fund that year, and quickly put it to work. Berkshire was busy making special deals with banks and motorcycle manufacturers, though it managed to work a deal to buy BNSF during the crisis era, too. Many others simply sat on their hands and kept their cash safely on the sidelines.
But 2008 may have been a rare opportunity, if not a once-in-a-lifetime event. Before 2008, Berkshire last deployed billions in junk bonds in 2002, a period that included a recession so short few remember it. As Buffett later admitted, the deals that came about in the aftermath of the tech bubble’s burst were short-lived. “The pendulum swung quickly,” he wrote in the 2003 letter to Berkshire shareholders about his $8 billion investment in junk debt, “this sector now looks decidedly unattractive to us. Yesterday’s weeds are today being priced as flowers.”
Berkshire may have the biggest bank account, and the most credibility when its name appears on a check, but it’s likely that only the very biggest of deals would be so large that it can be the only bidder. Blackstone, Apollo, and KKR have the capacity to do deals worth $10 billion or more, so called “megadeals,” in industry parlance.
It’s my personal view that Berkshire may be closer than ever to instituting a dividend policy designed to return at least some of its excess capital to shareholders. With so many well-financed peers shopping for assets at current prices, let alone depressed prices, it seems unlikely that Berkshire will get the chance to make a large deal at a truly privileged price unless we see another “once in a generation” downturn like we saw in 2008 and 2009.
Given the power of incentives — unlike Berkshire, private equity investors have an incentive to deploy capital to earn incentive fees — I suspect the $9 billion deal for utility company Oncor is just a sign of the times. Berkshire may have the capital to do big deals, but so does everyone else. Berkshire’s next dividend, the first since 1967, may come sooner rather than later.