LBO book

i don't mean to hijack, but how are PE firms who predominantly used LBOs funding their moves now?

Tuaj,

The short answer is, they are not funding their moves. While some PE shops continue to pursue additional acquisitions the majority of players are focused on streamlining operations at their existing portfolio holdings so that they can generate enough cash to pay down debt and survive the downturn. The problem is that much of the issued debt during the PE boom was covenant lite, interest only, with very high leverage ratios. I think we will see a string of portfolio company bankruptcies in the months to come. Luckily, many of the larger PE shops are well-capitalized and have a lot of dry powder on the sidelines that can be used for distressed opps.

I'm not so sure that we'll be seeing that many bankruptcies due strictly to covenant and liquidity issues. If the business is sound and receivables and payables are being managed, and it's purely a factor of being slightly overleveraged and amcro economic factors, a good PE shop will have set aside capital for equity infusions. We set aside roughly 5-7% of our fund as capital earmarked purely for add-on acquisitions and equity infusions.

In general, I agree with junkbondswap's assessment. That said, I also think GameTheory makes a good point -- I mean, hopefully we don't see a string of portfolio company bankruptcies. But evidently there have been some and there will be more, because the magnitude of the current economic downswing was not anticipated. Hopefully this is a process that good PE shops can manage on the whole (though there have already been some PE firms that history now shows us were too aggressive in pursuing companies when the markets were good).

I consider a group like Apollo to be a "good" PE shop but if you consider their recent string of bankruptcies (i.e. Linens N Things, their largest equity investment ever) you begin to see that the exuberance and hubris of the times along with cheap money got a lot of "good" PE shops into over levered unmanageable situations. When you confound these variables with a significant downturn in the global economy and a crisis of confidence it is tough to argue that we will not see a significant number of portfolio bankruptcies.

I agree. Apollo is a top tier shop. I remember having a conversation with a colleague of mine while recruiting. I had worked on an LBO involving probably 8 or 9 of the top tier PE shops at the time, and I got close enough to see what kind of structures each one was considering, how their lifestyles were, etc. I remember saying to said colleague that I would rather not go to a mega fund, in particular 3 or 4 which I felt were pushing the envelope in terms of leverage and structure (mind you, this LBO was done in the height of the debt markets). I mean, we were talking about structures where revolvers were being drawn at close to finance. So I guess I mispoke when I threw out the term "good" which is a subjective term. The conservative, long-term focused shops that didn't rely on financial engineering to do their deals should be fine. The mega funds that levered to the hilt with PIK toggles will probably be in trouble. Although I will maintain that there's a certain point in which it's purely economy driven and if you can make it to the other side without being in a work out situation, you'll be fine. Those are perfectly justifiable times to use your excess equity for infusions. Sometimes, the business is just so bad and unrecoverable that it's just catching a falling knife. Which is what is what happened with Apollo, Sharper Image (although Sun put in additional equity, but nobody ever said Sun was a "good" shop...), Werner Ladders, etc.

But I guess my fundamental argument to the private equity model that is that on a standalone basis vs. being private equity owned, alot of companies are much better off being private equity owned. There's no way a lot of these companies could survive the downturn, let alone make tuck-in acquisitions, without infusions of capital from their sponsors. That's part of what makes private equity so beneficial to companies in general, and why companies choose to sell to private equity.

For the record, I do know that a company we sold to a mega fund at 10x purchase, 7x leverage in January 2008 is now underwater for them.

how did u get 7x leverage in Jan 08?