Life after leverage

Mega-firms with dry powder are breaking the LBO mould to get deals done, writes Toby Mitchenall.

With the much-vaunted abundance of opportunities that comes with a downturn, mega-firms with mega piles of dry powder should be rubbing their hands with glee. However, in a world without leverage, they have to rethink the way they put money to work.

Toby Mitchenall

Among some of the deal types to gain momentum post-crunch, here are a few that characterise potential emerging trends and give an indication of how private equity’s giants will navigate an unleveraged landscape for the next few years.

Dealing in debt

Debt is the new equity, many a GP will tell you. Earlier this month a consortium comprising Apollo Global Management, TowerBrook Capital Partners and York Capital Management took control of French roofing business Monier in a significant restructuring. The consortium used a position in the business’ debt to galvanise lenders and prepare a debt-for-equity swap proposal that saw it wrest ownership of the business from its previous owner, PAI Partners. Other firms to approach deals via the back door of debt include Oaktree Capital Management – prolific in this area – Cerberus Capital Management and Lion Capital. Clayton Dubilier & Rice, meanwhile, recently hired European mezzanine veteran Christine Vanden Beukel to “explore a range of credit investment strategies”.

GPs taking minority stakes in listed companies might give their LPs cause for concern; why should investors be paying two-and-twenty in fees for someone to watch a publicly listed stock gyrating up and down with the markets? BC Partners – which recently paid $350 million for a 20 percent stake in listed US company Office Depot – would argue that, if executed with the kind of due diligence and control mechanisms you’d expect from a private equity firm, the strategy can yield outsized returns. With three seats on Office Depot’s board of 14 and various corporate and financial veto rights negotiated, it seems BC have not approached the deal lightly. Other recent PIPEs (private investments in public equities) include Warburg Pincus’ 10.3 percent stake in UK-listed food business Premier Foods and Actis’ stake in Tunisian conglomerate Poulina Group.

Boosting bolt-ons
Firms are allocating more dry powder to be deployed via existing portfolio companies. Sources say that one $5 billion fund recently told investors that it would channel $2 billion of its committed capital into bolt-on acquisitions via its current portfolio platform companies. In June an education-focused platform 20 percent owned by The Carlyle Group acquired UK-based group BPP in a £303.5 million take-private. Numerous factors, such as economies of scale and scope and familiarity with the industry make add-on acquisitions an appealing proposition in the current environment.

Aligning with the strategic buyer
In Apax Partners’ annual report released this June, chief executive Martin Halusa said the firm would see more situations in which it invests alongside “established corporate players”. Last year Apax teamed up with UK newspaper group Guardian Media Group to acquire publishing house Emap. More recently buyout giant Permira teamed up with Rupert Murdoch’s global media conglomerate to execute a $3.7 billion take-private of software group NDS. Investing alongside strategic corporates can provide many of the same synergies as bolt-on acquisitions. In some cases, such as BC Partners’ recent deal with Dutch heating company De Dietrich Remeha Group, it can provide a useful alternative to refinancing. BC’s portfolio company Baxi was in danger of breaching debt covenants, but a merger with its Dutch competitor provided scale as well as balance sheet security.

To the rescue
Amid torrid trading conditions, many highly leveraged businesses are bumping up against debt covenants, which means financial sponsors are being called to the negotiating table to hammer out a way forward with the lenders. As this tends to require an injection of more equity, it presents an opportunity for those with ready capital to step in and buy into the business. TowerBrook, which was part of the Monier consortium mentioned above, in March acquired a 62.5 percent stake in beleaguered French car parts supplier Autodistribution for an €88 million injection during restructuring. This week private equity firm Endless seized ownership of UK-based office supplies group Vasanta – formerly owned by rival firm Electra Partners – for an injection of more than £20 million.

Whether all of these deals will generate the returns that LPs have come to expect is as of yet unclear. These are times when innovation is key and some bold moves will be rewarded, while others will be picked apart as failed experiments. One thing is for certain, if 2009 produces the vintage year that most professionals predict, the stellar deals certainly won’t have been good old LBOs.