More private equity firms are establishing a private debt strategy by setting up specific credit funds or by using alternative debt in their deals.
As traditional debt providers slow down their lending activities, investment periods for European CLO vehicles are expiring and regulatory changes kick in, the availability of senior debt is likely to continue to decrease in the coming months.
Zug-headquartered Partners Group announced last week it raised its debut €375 million credit fund to meet increased demand for private debt. The firm focuses on mid-market companies with an enterprise value between €250 million to €2 billion. Partners Group has been investing in private debt since 1999, but has never had a separate fund dedicated to the strategy. Partners said it was “witnessing a transition in global credit markets” in which “private providers of credit can benefit significantly from the lack of alternative capital”.
Intermediate Capital Group (ICG) also launched a special credit fund which was fully invested after just six weeks, the firm said last week. ICG’s €65 million Total Credit Fund combines senior secured loans and high yield bonds in one credit portfolio. The open-ended fund has 5 percent cash left and invests in loans and bonds in medium-sized businesses with a value of €250 million to €1 billion. The fund invests in the UK, France, Germany, Benelux and the Nordic region. It is unclear whether the €65 million contains capital that ICG has invested from its balance sheet.
In addition, there are more firms seeking to benefit from the credit gap in the market. Ares Management recently raised its second European debt fund, which provides senior debt, mezzanine and co-investment equity in European mid-market companies. 3i Group also continues to extend its private debt strategy. Last month, 3i Debt Management agreed a joint venture with US based debt manager, WCAS Fraser Sullivan Investment Management, to gain access to the US credit markets.
Financing private equity deals
Firms with a private debt strategy do not just use these funds to provide debt to portfolio companies, they also finance other private equity deals. Last week, the debt arm of AXA Private Equity alongside Capzanine arranged a €37 million mezzanine financing for private equity firm 21 Centrale Partners. The French firm used the debt to acquire camp-site provider Village Center. This was an add-on acquisition following the acquisition of Vacances Directes, a tour operator for mobile homes, in December 2011. The €37 million of mezzanine debt was about 15 percent of the wider finance structure, which also included roughly 40 percent of senior and operational debt and less than 50 percent of equity, 21 Centrale Partners said. The deal value was undisclosed.
Guillaume Chinardet, director of private debt at AXA Private Equity, told Private Equity International: “21 Centrale Partners needed to find debt flexible enough in order to prevent refinancing the company’s existing debt. Mezzanine debt perfectly fits such a need and gives a lot of flexibility for future build-ups,” he said.
It’s good news to see newcomers to the debt markets, François Barbier, managing partner at 21 Centrale Partners told Private Equity International: “Given the global economic situation, banks are more selective and are reducing their exposure to private equity from their balance sheets. As banks are less present we need to find alternative financing.”
AXA Private Equity set up its mezzanine funds in 2005 and is now widening its strategy as a global private debt practice to fit the new market trends, the firm said. “Clearly the general private equity industry needs to find new ways to finance deals and that’s why private debt teams – such as ours – are ready to make new deals,” Chinardet said.
It is understood AXA’s debt team has $2.5 billion under management which it invests in Europe, the United States and Asia. The Paris-based firm declined to comment on the investment period of the debt fund. A source familiar with the situation said it is a four to six year term.
With more private debt funds entering the market, the possibility of double exposure has increased. There could be interaction between one firm’s private credit fund and its private equity fund. Last year, 3i Group invested in a Dutch retailer called Action. The €375 million financing was underwritten with debt provided by Rabobank, which the bank distributed in the syndicated loan market. 3i Debt Management happened to be one of the parties that invested in this and is now a lender in Action.
The firm, though, has rules in place to prevent any conflicts of interest, according to Anil Kohli, banking partner at 3i Group. “3i private equity and 3i Debt Management are two separate businesses. The two arms have different fund obligations they need to observe,” he said. Similarly, Partners Group's credit fund has no exposure to the firm’s private equity activities, a spokesperson told Private Equity International.
In recent years, the market has become much more comfortable with these different types of structures, Kohli added. “Everybody understands that they are different pockets of capital.”
For investors, credit funds can be an attractive way to diversify their capital. In the past, sub-investment grade debt investing has perhaps been misunderstood by investors, Garland Hansmann, portfolio manager at ICG, said. “Investors would invest only one or two percent of their capital in high yield. They didn’t want to worry about it,” he said. However, investment consultants have identified this more and more as a good option, he added. “As it becomes more difficult to make returns, it looks increasingly attractive.” His words are echoed by Kohli. “If you think about current debt pricing, it can be attractive for investors to allocate some of their capital to the debt space.”
And LPs have responded. At least three major LPs have committed to debt strategies this year. The New Hampshire Retirement System (NHRS) increased its allocation to alternative investments from 10 to 15 percent, with a 5 percent target allocation to private debt, the firm said last week. “After spending several months reviewing capital market assumptions and historical performance we felt that there were better opportunities for [good] returns in alternatives including private debt rather than staying in a 30 percent fixed income portfolio,” a spokesperson said.
In June, Arizona State Retirement System, which manages a $28.3 billion portfolio, said it considered to allocate a 3 percent target to private debt. An ASRS spokeswoman told Private Equity International at the time that “private debt offers favourable risk adjusted returns that are expected to enhance the return characteristics of the fixed income portfolio compared to core fixed income investments”.
In addition, The Massachusetts Pension Reserves Investment Management Board said earlier this year it has allocated $700 million for private debt investments in 2012. Similarly, The New Jersey Division of Investment set up a customised account with The Blackstone Group last December, allocating $1.8 billion with a flexible investment mandate across different strategies, including credit.
So investors, it appears, are starting to see the attraction of debt-related strategies, and more importantly, are willing to allocate in tandem with, rather than instead of, private equity investments.