Private equity firms that want to give good portfolio companies more time to weather the current financial crisis must be quick to recognise potential problems and be willing to revise the company's capital structure, according to Apollo Global Management co-founder Marc Rowan.
“The worst thing you can do is not address the problem, you can fail at addressing the problem, you can take a good try at it, but to be caught by surprise is really the ultimate sin for us,” he told delegates yesterday at the ongoing Milken Institute's conference in Los Angeles. “Extending the runway and allowing these companies to survive in a very difficult economic cycle is how our reputation will be made or broken over this cycle.”
Many private equity firms now own “fundamentally good franchises” that are suffering due to current extreme market conditions far worse than anyone projected. “Now the question is what do you do? You can certainly do nothing and rely on hope and prayer. Hope and prayer we have not seen as good strategies for our portfolio. What we try to do is assess in a downside scenario what is likely to happen.”
Apollo has had several portfolio companies fall victim to current market dislocation, such as bankrupt home goods retailer Linens 'n Things and struggling casino operator Harrah's. Apollo and co-sponsor TPG are currently buying back debt in the company, purchased in 2006 in a $16.7 billion LBO, to solidify their control position should the company file for bankruptcy.
“With our industry and many corporations in the US, it all starts with admitting you have a problem,” he said. “Private equity is very willing to say 'we're active management, we're actively involved in the strategy, we're willing to change management', but when it comes to changing the capital structure that's almost [viewed as] an admission of defeat.”
That mentality must change, as offensively changing a company's capital structure can help ensure its survival, stressed Rowan along with fellow panelists including Thomas H Lee Partners co-president Scott Sperling. For example, Rowan said, “Bank debt tends to be less forgiving, much more difficult to restructure, much more difficult to cope with when you're going through [a period of] adversity.”
Michael Milken, chairman of the Milken Institute and former 'Junk Bond King' of Drexel Burnhem Lambert, agreed that “for most enterprises, if you realise you have a liquidity issue due to maturity etcetera, then if you recognise it early enough you have a dilution issue, you don't really have a credit issue”.
Rowan noted that financial tools that have received negative press including PIK toggles, equity cures, second lien tranches and covenant lite loans will in fact be “the tools we're going to see companies [use] to survive or not survive”.
He also said private equity will be one of the industries most tested during this downturn given the high levels of leverage from deals done in 2005 to 2007, with some of that debt maturing in the short- to medium-term. “That is the biggest thing looming over the levered corporate marketplace today.”