New Uses for Dry Powder

LONDON (Reuters) – Private equity firms need to persuade skittish investors that buying discounted senior debt is a viable way to make money as the credit crisis has put a virtual halt to leveraged buy-outs, once their bread and butter.

The industry is sitting on about $450 billion of capital it raised for buy-outs but is looking for new ways to use this so-called dry powder.

Many companies are now scooping up heavily-discounted senior loans in secondary markets that offer an equity return of at least 20 percent, but their clients remain wary as highly-leveraged companies struggle in the deteriorating economic environment.

“I would be very nervous about buyout firms buying debt because they fundamentally are equity investors,” said Billy Gilmore, investment director of Scottish Widows Investment Partnership’s private equity division (LLOY.L: Quote, Profile, Research, Stock Buzz). “I would be more inclined to back funds with more of a banking and a credit mentality.”

But he added: “If you can convince yourself that the underlying company is not going to go bust and will repay its debt, you can actually make a private equity return with a senior debt risk.”

Private equity firms were initially looking at buying back debt in their own companies, but are now spreading the net wider to deals generated by other sponsors after heavy technical selling depressed some secondary loan prices to levels viewed as bargains by savvy investors able to avoid credit losses.

They are typically interested in buying the senior debt of stable, cash generative firms that offer value at current levels, most typically in the 40-60 percent of face value range, loan traders said.

The assets are bought by private equity firms’ trading arms and are put into separate loan funds with Chinese walls from their parents, loan traders said.

“Private equity is becoming more important in terms of the buyside than it used to be. Some have got loan funds, some are setting up funds and some are pondering setting up funds,” a loan trader said.


Private equity buyers are steering away from shakier companies and often focusing on names they know well, typically where they were a losing bidder.

Credits that private equity firms have shown interest in include Spanish industrial bread and confectionary manufacturer Panrico, which was bought by Apax Partners in 2005.

The company’s senior debt is quoted by traders at 59-62 percent of face value, its second lien is seen at 51.5-54.4 percent and its Payment-In-Kind (PIK) loan is at 20-25 percent.

“You can buy Panrico’s PIK in the mid 20s if you believe and are prepared to love it long time,” a senior loan trader said.

Ista International GmbH is another stable and cash generative — albeit highly leveraged — German metering company that is also catching the eye of private equity firms. Ista was bought out by Charterhouse in 2007 backed by 3.4 billion euros of debt, which traders are quoting at 58-62 percent of face value on its term loan B and 35-40 percent on its second lien tranche.

French broadcast tower operator Telediffusion de France is a third name that is attracting sponsor interest as one of the leveraged loan market’s most stable names with a near-monopoly status and long-term broadcast contracts. The company, which belongs to TPG and Axa Private Equity, is quoted at 58-61 percent of face value on its senior debt and 38-41 percent on its second lien.


Electra Private Equity Plc recently said it is eyeing opportunities in senior debt, but while its listed status with a more traditional shareholder base affords it the freedom to pursue deals other than the traditional buyout, other firms may find themselves constricted by the terms of their investor agreements.

Ian Bagshaw, private equity partner at law firm Linklaters, said many traditional buyout funds were sold on a “plain vanilla” basis and do not have the latitude to look at opportunities in other fields.

“There are some sponsors who can do it and some who can’t. And some want the flexibility from LPs (limited partners) to do it, but that comes down to their skillset and relationship with their LPs,” said Bagshaw.

He said those funds that have the support of their investors, and who bring in debt acquisition specialists, will participate in buying discounted debt.

However, in order to capitalize on the opportunity, private equity firms will need to move quickly as the discounts are not expected to last forever.

“This is often not in private equity firms’ articles of association, it’s a one-trick pony, a one-off opportunity for the next one and a half years that when invested will run off,” a second loan trader said.

By Simon Meads and Tessa Walsh
(Editing by Chris Wickham)