Pending tax changes could have a profound effect on leveraged buyouts, David Fann, president and CEO of TorreyCove Capital Partners, told a conference.
The House of Representatives voted late Monday to go to conference on its tax bill, which includes a provision that caps interest deductibility at 30 percent of adjusted taxable income. This is a huge change from the current 100 percent now allowed.
The legislation is the “worst nightmare” for private equity firms, Fann said during a keynote speech at Buyouts Insider’s PartnerConnect Southwest. “Congress has changed the rules for private equity, essentially taking the leverage out of buyouts,” he said.
He likened the bill to an episode of “The Twilight Zone,” where at least viewers get to wake up from a bad dream.
PE firms won’t be able to borrow as much as they used to on a tax-efficient basis, he said. The bill would be a “game changer” for private equity and create real challenges for high-yield and mezzanine funds. “It really favors preferred stock in the equity market,” Fann said.
If the changes go through, 2018 will be a “busy year for M&A, a busy year for restructuring,” he said. “There will be a lot of deleveraging of the balance sheets.”
Later on Dec. 5, Christopher Shelling, director of private equity at Texas Municipal Retirement System, said the House bill would require pension plans to pay taxes on unrelated business taxable income or UBTI, a common type of earning that PE funds generate. “It is impactful,” Shelling said. “Most public pensions take the view that they’re tax-exempt.”
If pension funds are subject to UBTI beginning Jan. 1, “retroactively every single partnership in our portfolio will get hit with a tax bill,” Shelling said. Estimating the size of the tax bill would be difficult, he said. “For large investors, it could be substantial and detrimental to returns,” Shelling said.
But John Neuner, managing director and co-head of the consumer group at Harris Williams, provided a different view. “Nobody is scared off by the tax changes coming through,” said Neuner, who spoke on the panel, “Buy, Hold or Sell? What are the Valuations Indicating?”
Harris Williams has “modeled out a bunch of different scenarios,” Neuner said. Whether a company is affected by the tax changes depends on the sector it is in and its profile, he said. He pointed to companies in the industrial sector and “high-capex, low-margin businesses” as likely to be affected more, he said.
“We don’t have a huge group of people lining up to sell,” Neuner said.
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