Friday the 13th: LBO Bodies To Pile Up

There are three Friday the 13ths in 2009. Four if you count the remake of the 1980 video nasty. And the bodies are expected to pile up, as private equity firms and their portfolio companies face their own slasher horror nightmare.

Keen-eyed calendarphiles at the Financial Times have noticed that companies bought with riskier loans are given 45 days from the end of a quarter to confirm that they have met their covenants, meaning that from today there could be significant blood-letting.

Covenant breach negotiations have already begun for a number of firms. This week, Candover entered debt facility negotiations when Italian luxury yacht maker Ferretti missed an interest payment, and earlier this month, BC Partners announced that it was in talks with banks over both its Swedish luxury boat fittings business Dometic and its ill-timed flirtation with the property market in London-headquartered estate agent Foxtons.

At the same time, in the same sector, Apollo Management was appointing an adviser to review the capital structure of its $1.9 billion purchase of Countrywide in 2007. No wonder founder Leon Black has been making dodo/extinction analogies with big buyouts for much of the last year as his firm retools itself for largely debt investing.

As a side note, the Wall Street Journal suggests that a measure within Obama’s stimulus package could benefit debt-focused buyout firms, enabling private equity and portfolio companies to defer income taxes when they repurchase their own debt at a discount.

Back to the dodos, Candover’s €1.7 billion purchase of Ferretti was Italy’s largest LBO of 2006 and a secondary buyout from Permira. The practice of private equity firms swapping assets got a pummelling at the recent SuperReturn – where Carlyle’s Rubinstein noted there would be a slew of defaults this year – mostly because the rationale now appears to have been a surfeit of raised capital and cheap debt, rather than a sense that a new, most likely larger, private equity firm could pump in more money and has more experience of managing bigger companies.

Taking a firm to the next level is the mantra. Cinven’s purchase of retirement solutions business Partnership Assurance from Phoenix Equity Partners for €200 million last June is one example. Cinven invests from a €6.5 billion fund, Phoenix from a £375 million vehicle. The differences are obvious and what Cinven can provide – “the next phase of the company’s development” as Phoenix managing partner Sandy Muirhead put it at the time of the transaction – Phoenix can’t.

Permira’s decision to give its fund investors breathing space and lower the overall size of its fourth fund notwithstanding, there is less of a gap between the now-global firm and London-headquartered Candover – Candover has invested in 137 buyouts worth €46 billion since 1980, raised a €3.5bn fund in 2005 and partnered with Goldman Sachs and AlpInvest for the $3.77 billion buyout of UK oil field services business Expro in July of last year. At least in terms of size and what new it could offer a firm already subject to a private equity once-over.

Candover may have had sound reasons for the transaction, but they aren’t immediately obvious. Ergo: don’t do secondary buyouts unless you can clearly justify them. And probably avoid yachts and estate agents.

In addition, the Partnership Assurance deal was all-equity, another nod towards private equity’s immediate future. That’s to say, all-equity deals involving already indebted companies, providing investors their leverage comfort zone and, where they fit the “next phase” secondary buyout mould, investee companies some degree of stability in remaining under private equity ownership.

The next Friday 13th is in March. Too early for a bloodbath. By November, however, expect some nasty smells from down at the lake.

This post first appeared at Thomson Merger News