Jon Moulton: PE Faces Default Time Bomb

LONDON (Reuters) – Close to a third of the private equity industry’s mid-market portfolio companies could fail as the economic downturn across Europe turns into recession, the head of a leading mid-market private equity firm said on Tuesday.

“It really would not be surprising in this recession if 30 percent of portfolio companies in the mid-market buy-out firms actually failed,” Alchemy Partners managing partner Jon Moulton told the LSE Alternative Investments Conference in London.

Moulton drew a parallel to the last recession in the early 1990s when he said receivership was the most common and most valuable form of exit from private equity deals.

He added that while mid-market firms will see a lot of failures, “they will still come out better than mega funds because they had less debt going in”.

Cheap-and-easy bank debt fuelled the growth of mega buy-out deals at increasingly high multiples through the middle of this decade, culminating in KKR’s European record deal to take Alliance Boots private in 2007 for 11.1 billion pounds ($15.59 billion).

Now the deals done in 2006 and 2007 are widely seen running into difficulties as worsening outlooks and falling asset prices put firms into breach of their covenants.

While Moulton acknowledged that leverage is useful for boosting returns, he said its political impact is beginning to “bite home” as staff in companies pushed over the edge by their debt burden lose their jobs.

“I think those that have overgeared themselves are going to get into difficulty and (are) not going to be able to make it,” said David Fitzgerald, managing director at U.S.-based private equity firm The Carlyle Group.

“The key thing is not breaching the odd covenant here or there, the key thing is actually ensuring they can service debt.”

Fitzgerald recognised the reality that some companies would fail, but said it was impossible to put a number to the potential level of default.

“In essence, there are going to be defaults, but there are going to be as many defaults in the public markets as the private markets; I think it’s unfair to draw the distinction,” he said.

However, as a result of a rising tide of defaults in private equity companies, Moulton believes the spectre of regulation from Europe looms large over the industry.

“We don’t really need regulation but we are going to get regulation on us because of the perception that we are really bad,” he said. ($1=.7118 Pound)

By Simon Meads
(Editing by Simon Jessop)