Editor's Letter: The importance of creative capital

Dear Reader,

I wrote recently that it’s tempting to view debt as simply numbers on a balance sheet. But for borrowers, living and working with debt is a daily issue. That’s why putting together an appropriate capital structure is so important.

Of course, the obvious question is, ‘Appropriate for who’? A borrower’s set of priorities will be very different to an issuer’s. But the true skill lies in tailoring loan products to suit the needs of both. It’s in this regard that private debt funds can really distinguish themselves from traditional lenders.

Banks often view loans (and by ‘loans’ we’re really talking about leveraged finance instruments) as a means to an end, the end being persuading the borrower to pay for a host of other services. Many will syndicate loans and retain very little, if any exposure, so the income is derived initially from the arranging fees and then later from those other banking services.

By contrast, non-bank lenders will typically hold the debt they issue to maturity. As a result, skilful managers will look to structure the debt to provide the desired protection and of course returns, whilst giving the borrower the flexibility it needs to grow.

Speaking to Permira’s Max Biagosch, the subject of our Capital Talk interview this month, you get a sense of what it is to work with debt on a daily basis. A financing specialist needs to consider how debt will play within a buyout target’s capital structure long past acquisition, and whether it will serve a company’s changing needs as it evolves and grow. Working with the right debt providers, be they bank, a fund manager or an institutional investor, is obviously paramount to obtain the most appropriate form of financing. 

Get it wrong of course, and you not only face suppressing performance, but potentially losing control of the company altogether. What looked like a sensible capital structure in 2006, for example, probably didn’t look quite so clever five years later. For a sponsor-backed business, operating under a too-onerous debt burden is counter-productive; oppressive leverage will simply curb growth and at worst lead to default. That’s not in a lender’s interests either (unless you’re a loan-to-own player, in which case, that’s exactly what you’re after).

Unwieldy debt packages have hit the headlines recently, with TPG and Apollo Management-owned Caesars Entertainment restructuring itself in a bid to lessen the load of its $24.1 billion debt. We dissect another monster buyout, KKR and TPG’s ailing power company Energy Future Holdings (formerly TXU).

We discuss the refinancing challenge in detail, and it’s certainly a substantial one, with an estimated $46 trillion of debt coming to maturity in the next few years.

Borrowers refinance for a multitude of reasons: opportunistically, to reduce the cost of a debt package; to return equity via a dividend recap; to provide additional working capital; to push out maturities or give additional headroom. Understanding the tools available is key in a rapidly-evolving market, and one which Blackstone president Tony James describes as “ebullient”. We bring you a glimpse of a forthcoming book, “The Refinancing Guide”, in which SL Capital Partners’ chief investment officer Peter McKellar provides an investor’s insight into how GPs communicate refinancing issues to their LP base.

We hope you enjoy the issue.

Oliver Smiddy