Just because private equity is seeing some renewed enthusiasm doesn’t mean its “back.” Call me a pessimist, but remember that near-half a trillion dollars in corporate debt? It’s due in three years and it hasn’t gone anywhere.
None of the indicators being discussed today –exits, increased deal volume, rising stock markets leading to rising mark-to-market valuations — address the real issue of portfolio company performance under crushing debt loads.
It wasn’t long ago that Deal Professor declared private equity “dead, dead, dead,” we wondered if it was time for private equity “to finally freak out” and numerous stories warned of a tsunami of buyout-backed bankruptcies caused by a crushing tidal wave of debt maturities. BCG predicted that 40% of all buyout shops would go under (a study we considered to be a bit dubious, yet various white papers and studies continue to cite it). While the BCG study was clearly headline-fishing, the study’s methods did do one thing right-it highlighted portfolio company debt.
It really won’t matter if private equity can raise and deploy funds if its portfolio companies are still unable to reduce their debt loads. Despite all of the IPO fever, I believe the majority of large buyout-backed companies (particularly those under private equity ownership for only a few years with maturities still several years out) will need to do some serious balance sheet revivals before they think about public market debuts. The average leverage for KKR’s top nine portfolio companies, for example, is 5.4x debt-to-equity. Companies could concievably use the proceeds of its IPO to pay down some of that debt, but that requires getting investors to support the debt-laden company first. Successful PE-backed offerings like Bridgepoint and Rosetta Stone may have their lack of debt to thanks. The performance of of Silver Lake and KKR-backed Avago’s offering this week will be an indicator of the public’s appetite for debt-laden IPOs, as the business has 1.5x leverage on its balance sheet.
That’s why we’ve seen so many distressed debt exchanges: This year 60 issuers have undergone distressed debt exchanges at more than 4x the full-year value of exchanges for 2008, according to S&P. And as the name indicates, those aren’t positive for all parties involved.
The good news here is that the debt markets aren’t 100% closed to refinancing for these buyout-backed businesses, even though the term mega-buyout still elicits scowls on the faces of LPs. Buyouts’ Ari Nathanson reports today that buyout firms are working with lenders to “amend and extend” their debt agreements. Last week Blackstone COO Tony James said in the firm’s second quarter earnings call that recently, banks have been more willing than in past months to amend terms and “kick the can down the road,” regarding maturities. That’s led to less distressed situations and bankruptcy filings than some people expected, he said. Weeks prior we noted the same phenomena in the middle market, as lending sources noted that lenders have warmed up to the idea of refinancing debt at a “middle ground,” pricing facilities somewhere original terms and current market prices.
So it may be too early for private equity to declare it has conquered its debt conundrum, but signs for that victory are certainly showing signs of improvement.