Repo Man
Private equity has not yet confronted its achiles heal - debt. In fact, deleveraging has only just begun, but it will: S&P LCD reports in the US, the top or "mega" buy-out firms have >$400 billion of responsibilty on their portfolio. These firms face over $21 billion of debt maturities in the next two years, followed by another $50 billion in 2012, $115 billion in 2013 and $192 billion in 2014. And you think your mortgage bad. The over-leverage originated from 2005 to 2007 when credit easy and PE firms took on lots of companies in multi-billion-dollar deals. Now, with credit availability gone, refinancing has become increasingly difficult and firms are seeking new ways to do so. Some are putting new equity into their portfolio companies, selling stakes in businesses to strategic buyers and then buying back debt in their own companies at a discounted rate. Firms are also attempting to persuade lenders to extend maturities on existing loans. The Financial Times notes KKR has successfully pushed back the maturity date on loans coming due in one of its biggest buy-outs so presumably others will to.
Debt, of course works both ways. During cheap credit cycles leverage most efficient whilst de-leveraging a business via its cash-flows creates equity value for investors. It also increases substantially the potential return: Buying a company for $100 then selling it for $110 nets a $10 gain or 10% gross irr over a year. Buying and selling the same asset at the same prices but using $90 of debt results in a $20 gain on the initial $10, or a 100% irr over the same period. This a 10-fold increase in performance. Of course, the debt must be serviced and often this means redundencies or failure when times slow, like today. We may yet see many companies go tits up. For good or bad, the greatest (hubristic) transactions from the largest firms - we then argued that scale a competitive advantage and the bigger the best since larger deals face less competition (fewer dudes can afford the deal) so better terms and indeed, the largest transactions >$1 billion went for multiples 5-6.5X while mid-market or <$1 billion 7-9X from 2005-07. But now the chicken has come home to roost and payments must be .. paid.
Good news, then, that there is some considerable negotiation between borrower and lender since neither wants failure. Restructurings occupies a lot of GP time, which is not good if you are paying a 2% fee to a manager to invest your dough. This not the funds competency, after all. But what alternative, really? This is where we need a Repo Man - remember Emilio Estevez? Now that was a cool flic. He'd solve our problems fer surz.
