Tuesday, June 9, 2009

Reflections on private equity

David Carey put out a nice write-up on private equity/LBO, dealing with issues of excessive leverage of the 04-07 vintage deals. Here are some interesting highlights:
* Private equity firms continued to raise new funds last year, raising a total of $550 billion in new commitments.
* Sarbanes-Oxley ironically drove some firms to go private
* Buyout firms now command some $450 billion in committed but un-invested capital.
* About $430 billion of senior debt used for leverage in acquisitions from 2004 to 2007 deal spree is maturing between 2012 and 2014. Unless the leveraged loan market opens up dramatically, it will be difficult to refinance these deals. That will destroy equity valuations.
* Even if refinancing will be possible, it will be more expensive, hitting equity IRRs promised to investors.
* The problem deals are mostly the 55 “megadeals” done recently ($5 billion - $45 billion in size). According McKinsey megadeals represent about $240 billion (40%) of the equity capital from 2004 to 2007.
* Some already went bust: Chrysler LLC (Cerberus), Aleris (TPG), Tribune Co. (Sam Zell) and Linens 'n Things (Apollo)
* An interesting observation comparing current deals with RJR Nabisco/KKR:
"There will be a lot of RJRs," one buyout specialist predicts, alluding to KKR's $31.3 billion buyout of RJR Nabisco in 1989, which held the size record for an LBO for 16 years and which lost money for KKR. "Not bad companies necessarily, but companies with capital structures the sponsors can't extricate themselves from and that can't be refinanced."

* Recently, with the opening of the bond markets, some firms have been issuing senior bonds to take out their outstanding loans. Even though it’s significantly more expensive, the refinancing extends maturities, giving these firms some breathing room.
* Risk management on the LBO deals was skewed by the massive fees generated.
* Boston Consulting Group says that 20% to 40% of all PE houses will close down.

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