L.B.O.’s: Don’t Call It a Comeback

December 7, 2010, 10:02 am
By HEIDI N. MOORE , NYT DealBook
The buyouts last month of the big consumer names J. Crew and Del Monte were two promising signs that private equity firms were ready to come out and play again.
But don’t call it a comeback.
Sure, on the surface, there seems to be a reasonable resurrection. The volume of global leveraged buyouts have more than quadrupled this year, according to Dealogic data. Private equity firms have spent $73.6 billion on 193 deals in 2010, compared with $16 billion for 76 buyouts over the same period in 2009, noted Dealogic.
But dig deeper into the financing, and the story looks grimmer.
The private equity business runs on debt — mainly the leveraged loans and junk bonds it takes out to buy companies. As DealBook has noted, there has been a boom in such debt this year, with new records set for issuance.
That is not necessarily a good sign. Rather than funding new deals, most of the financing activity has helped private equity firms sustain their current investments, which would be in deep trouble without the help. It’s a survival play, as their portfolio companies are loaded up with debt that is quickly coming due.
The wall of refinancing that these firms face may be $100 billion more than many expected, according to Moody’s.
And private equity firms are trying to sign longer loans to avoid having to refinance again soon. The average L.B.O. loan is now 5.6 years in length compared with 5.2 years just last year.
According to Dealogic, private equity firms are signing very few fresh deals. The current volume of loans backing new buyouts is 89 percent below the record of $681.5 billion set by this time in 2007. The value of deals that private equity firms have exited is 44 percent lower than the $279.6 billion they racked up by this time in 2007.
As the industry battles its dependency on debt, private equity’s long winter may rage on for awhile.
The chill seems to have set in shortly after two blockbuster demonstrations of private equity power in 2007: the buyout of Hilton Hotels and the initial public offering of the Blackstone Group.
In 2008, private equity firms broke up — or tried to break up — richly priced deals they had signed in flusher times.
In 2009, private equity firms had plenty of cash but little access to the debt markets to deploy their strategies.
In 2010, private equity firms, with two years of weak exits and skimpy returns, had trouble fund-raising. According to Prequin, 242 funds raised $116 billion in the first half of 2010 compared with 336 funds that raised $171 billion in the second half of 2009.
In 2011, the industry’s revival may depend on whether firms can work through their debt issues while the markets are still open. To do that, private equity may have to scale back its ambitions and operate more cautiously, looking for known quantities rather than grand risks and high returns.
As the longtime investment banker Kenneth D. Moelis pointed out at a conference last week, the J. Crew and Del Monte deals were still relatively small in size for private equity deals. He predicted that such smaller buyouts would become more common, as private equity gave up its dream of the $100 billion “Big One” and focused on the more mundane job of turning around midmarket companies.
Consider one of the bigger potential deals: the Carlyle Group’s public offering. While Blackstone cashed out when times were good and valuations were high, William E. Conway Jr., a Carlyle founder, recently told Bloomberg News that the firm was going public because it was harder to get access to capital.
It’s a good insight into private equity in the aftermath of the financial crisis: the big players, once known to embrace risk and swagger, are stuck looking for sustenance for their troubled companies.
The barbarians at the gate are looking more like beggars these days.