In the event of a completely new financial paradigm as JPow seems to be alluding to - sustained levels of higher interest rates (at least higher than the 0% we've had), weakening consumer - how screwed are funds that deployed massive amount of capital the past ~5-years: i.e., ~peak multiples x ~peak earnings (last ~12 months) x ~peak leverage off fake EBITDA?
I just don't see how anything but the strongest companies are going to take a bath on valuation. Of course PE funds will try to hold the marks as long as they can - but at some point, many will be completely behind on realizations and distributions and they're going to run out of dry powder for the next fund, no? Funds can only hold the marks for so long before LPs call BS.
What am I missing? This seems pretty bad for funds that invested significant amounts of capital the last 5-years, no? Continuation funds might save some - but feels like a tough environment. Conversely, feels like a better situation for funds that had significant realizations last ~3-years and/or recently raised new capital?
Don’t rely on advice from people who’s paycheck depends on pulling one over on someone.
Leverage is less of a problem than you would think because they were fairly cov light
1. They're only cov-lite for large syndicated deals - they are not cov-lite for direct lenders
2. Even for cov-lite deals, many companies are going to have trouble refinancing that loan when it comes due due to a combination of higher rates, potentially lower earnings, and what banks will look at as higher LTVs
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Wasn’t the debt secured at a fixed interested rate for the companies they’ve already bought? Why would the raise in rates affect those?
You’re familiar with how LIBOR works correct?
No, but just looked it up and it seems like the lending rate between banks. I’m not sure why changing rates would affect deals where the debt was already secured at fixed rates. Not doubting that you are correct (you clearly know more than me), just not understanding why you’re right.
You got the education on floating rates from other posters, but you weren't necessarily wrong in one respect: some sponsors may have entered into interest-rate hedges to minimize the risk of exactly this happening. I work for a LMM fund and we hedge about 50% of our floating-rate exposure (so on a $100mm facility, $50mm is at a locked-in interest rate).
Would be curious on how the smarter financial engineers have thought about this (or if it's even common at UMM/MF shops), because I just don't know enough to provide a definitive "LOL no problem" or a definitive "LOL no we're f'd".
In addition, loans from covid days will be due in the next 1-3 years at a higher rollover rate, which will be challenging for smaller, non-profitable businesses
It’s made for a much more interesting market, that’s for sure. I can think of around 5-10 multi-$BN equity checks written by “top tier” sponsors in 2021 that right now look like they will be zeros (targets that transacted for 12x+, with 6x+ leverage that will never get refi’d, that we’re really 7-8x type businesses and are now levered FCF-negative). My guess is you will see a wide dispersion of outcomes across sponsors, favoring strategies based on lower purchase multiples / lower leverage / higher levered FCF yield.
Two of my favorite ones:
1. A certain sponsor paying ~mid-teens+ for a car-tire changing franchise...
2. Another sponsor paying ~mid-teens+ for office water cooler services
I think this whole situation exposes the fundamental structural problem with PE funds. There is a principal-agent problem. Funds are highly incentivized to deploy capital - it's very asymmetrical upside / downside. When valuations all got crazy, the real answer was for most funds to go on vacation for 3 -years - that would have been 'best' for LPs. But the whole eco-system was so screwed that if you don't choose to play this game of hot-potato, you are probably not getting invited back to the party. So what does everyone do? Play the game and hope to god they potato doesn't land on them when the music ends. Buffett was right all along - massively sit on cash and be very opportunistic. But he has an investment partnership that allows him to do that...
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