Commentaries and insightful analyses on the world of finance, technology and IT.

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November 19, 2009

The Market is Ok with Debt from Private Equity Investing (to a point)

There have been many entries composed on the issues of excessive debt used in leveraged buyouts. In some instances, this excessive debt load in an underperforming market has led to severe distress or bankruptcy for the portfolio company (most recent example being Simmons Bedding Company, a TH Lee holding, filing Chapter 11). However, public markets and some new research are providing a new perspective on the subject.

 

 The Moody’s Global Corporate Finance report (www.moodys.com) examined over 200 Private Equity (PE) transactions showed that PE owned companies defaulted at roughly the same rate (19.4%) as similar companies not acquired with leverage (18.6%). However, it does go to state that those companies will experience higher distress in this down period (leverage is great for returns in an up market, bad in a down one so no major surprise). The real outliers were the “mega-deals” which could only happen in such a lax lending environment, probably should not have happened and are the worst performers. Removing those outliers, the difference is very small and calls into question to what many naysayers state regarding the ability of PE to create value with their riskier investing style. What is even more interesting to me is that the data showed that club deals (when multiple PE firms are involved) defaulted at a lower rate (15.6%) than non-PE owned comparison companies. This seems to be a case of more eyes on the initial diligence and eventual guidance of the acquired firm.
Public markets are also not showing major concerns for this debt load either. PEHub reported that since August PE-backed IPOs have finished 6.65% higher than their IPO price (with only a few exceptions). With investors still moving to quality while our markets continue to recover, this is a pretty big vote of confidence in the PE approach.
This style not only weathered an incredible downturn, it has seemingly held up quite well in comparison. However, the big question remaining is if the bond and leveraged loan market recover enough to accommodate the refinancing required for the PE maturing debt in the 2011-2013 window (also called the “debt wall”) from the boom time run up. This will be key to ensure these default rates hold steady instead of rapidly accelerating. 

Posted by Jeremy Kloubec at 04:10 PM | | Comments (0) | TrackBacks (0)

November 16, 2009

To boldly go where no man has gone before

As 2009 comes to a close, many of our colleagues are taking into considerations two, prima facie opposing, business realities into account while finalizing the technology budget for 2010.  

The new economic paradigm points towards tightening of the budget. There is unprecedented respect for liquidity and savings among both corporates and individuals. Companies have increased profitability by reducing costs and squeezing productivity out of existing assets.


However, there is a significant pent up demand with IT cutting down on discretionary budget across the board for more than a year now. Also companies have gone too far in keeping liquidity – as per WSJ,  500 largest nonfinancial U.S. firms, by total assets, hold about $1 trillion in cash and short-term investments. Last, the market continues to evolve e.g. in payments industry new players have established a significant presence in owning client relationships (refer to my paper on payment industry at http://www.infosys.com/industries/banking-capital-markets/electronic-payments.pdf) .
 

Above two factors are going to push budget decisions based on clearer business case and tangible, well articulated justification. This is the time which would distinguish visionary CIOs from also ran. CIOs that can convince the board based on well justified investment strategies have a lifetime opportunity to make their companies stronger and much more competitive before others catch up.

Posted by Neeraj Kumar Jindal at 04:55 AM | | Comments (0) | TrackBacks (0)

November 15, 2009

Q2 Capital Call Uptick, but Distributions are Holding Steady

Cambridge Associates (www.cambridgeassociates.com) put out a report last week noting their Private Equity Index firms made $7.4B in equity calls for Q2 of this year which was in increase of $1.1B from Q1 2009. What is curious that new acquisitions have not increased by a commensurate amount during the same time period, but would hint towards increasing activity to come. Many PE firms I have spoken with seemed extremely slow during Q2 with very weak deal flow. That did not seem to shift until only Q4 of 2009, still with few deals actually closing.

 

 My guess is that there were some leading indicators of activity that were read by bullish managers, however, my guess may even be that firms were looking to secure funding to ensure it was available. Limited Partner (LP) contracts are extremely airtight, but you can’t get money from a bankrupt or distressed entity, so this looks like a bit of self-preservation by private equity. Alternatively, it could be an act of staying ahead of bad news as fund distributions over the same time period were holding steady meaning that LPs were working at a net negative in some cases. The good news in all of this is that the Cambridge Private Equity Index did appreciate by 4.3% in Q2 being lead by Retail, Financial Services and Energy which were previously hard hit segments. The issue here is being that the Dow surged approximately 8.5% during the same time period which would possibly lead to some interesting General Partner/Limited Partner conversations. I will try to reach back out to the network for an interview with a fund raising expert to provide their point of view in an upcoming blog entry.

 

Posted by Jeremy Kloubec at 11:07 PM | | Comments (0) | TrackBacks (0)

November 06, 2009

Emerging From the Mess

I was looking back at some reports from a year ago and the predictions almost seemed a bit surreal. Almost half of all buyout firms were predicted to dissolve along with the majority of their portfolio holding companies going in debt default. Debt financing was gone, earnings and multiples were collapsing along with the broader market, Institutional Investors were going to pull back their private equity allocations, in other words, the bottom was going to fall out for private equity buyout firms. Were these Cassandras simply incorrect in their warnings?

 

 

Actually, at the time, even though it becomes harder to remember as time passes, it really did look that bad. It is a testament to architects of our recovery who have been trying to keep this economy together that we actually have a semblance of normalcy. Not that everything regarding our economic recovery has been successful (namely jobs) and all of the above did happen with adverse impacts on private equity. What is surprising was how private equity was able to ride this downturn out. Sure, there were some layoffs (an industry first), portfolios were written down, portfolio companies were pushed to the edge of bankruptcy and fund raising was stalled.

When deal flow dried up, the focus turned to portfolio operations to add value, creative re-financing options were found as banks were not eager to acquire distressed assets with some firms becoming their own debt investors and Limited Partners were given some commitment reprieves while their own investments started to climb back. All of this was aided by the recession easing and the significant amount of unallocated capital raised by private equity before the crash which provided that buffer during the downturn by keeping the lights on with the use of management fees. Granted, the pain was distributed more heavily with the smaller funds due to fee structure, but on the whole, this sector group has held together. Even more surprisingly, it is set for a significant rebound if you believe the leadership of these firms who are looking at discounted assets in the market. To steal a Mark Twain quote, maybe private equity could have stated “the reports of my death are greatly exaggerated” to some of those yearend 2008 prognosticators, but I could hardly be one to judge their assessments at the time.     

Posted by Jeremy Kloubec at 08:40 PM | | Comments (0) | TrackBacks (0)