By Chibuike Oguh and Anirban Sen
(Reuters) – Private equity firms that have been acquiring companies since the banking crisis began on March 8 have funded deals largely with their own funds, a departure from traditional leveraged buyouts that reflects their struggle to secure cheap debt.
Four private-equity takeovers announced in the past two weeks were financed with debt that represented between 9% and 50% of the deal size, according to a Reuters review of regulatory filings. The rest were equity reviews of private equity firms.
Typically, debt accounts for between 60% and 80% of transaction costs, allowing buyout firms to generate returns.
Private equity executives and their advisors say the shift toward more equity funding began ahead of the banking sector turmoil this month, as rising interest rates over the past year made debt more expensive and fears of an economic slowdown tended to bolster lenders risk averse.
But that trend intensified after three US banks collapsed this month and concerns about banking sector resilience forced many lenders to pull out, they added.
“Private equity investors need to be selective in their positions and have a very strong conviction to complete a deal,” said Rob Pulford, partner and head of the Financial and Strategic Investors Group at Goldman Sachs Group Inc.
Chart: US private equity-backed M&A declines https://www.reuters.com/graphics/GLOBAL-BANKS/BUYOUTS-DEBT/jnvwyjjzmvw/chart.png
When Blackstone Group Inc completed its $4.6 billion acquisition of US cloud-based events software provider Cvent Holding Corp from Vista Equity Partners on March 14, it only raised $1 billion for the deal. The rest came from Blackstone, the Abu Dhabi Investment Authority and Vista, which transferred part of its stake to Cvent.
Similarly, on March 12, Silver Lake and the Canada Pension Plan Investment Board agreed to buy data analytics company Qualtrics International Inc for $12.5 billion, using just $1 billion in debt.
Apollo Global Management Inc on March 14 signed an $8.1 billion agreement to acquire specialty chemicals distributor Univar Solutions Inc.
Symphony Technology Group on March 13 agreed to acquire Momentive Global Inc, owner of online survey provider SurveyMonkey, for $1.5 billion using just $450 million in debt.
Six private equity firms polled by Reuters said they had not revised down their typical annualized return expectations of 20% given the difficult environment for debt financing. They asked for anonymity as such numbers are kept confidential between the companies and their investors.
Bob Rivollier, a private equity partner at law firm Ropes & Gray, said many buyout firms that rely heavily on equity funding believe it’s possible to achieve the returns they’ve seen in the past , adding debt to the companies they later buy. This has made return assumptions for these deals more precarious, he added.
“Equity is not cheap. Between a deal where 40 percent is equity and 60 percent debt and a deal where 100 percent is equity, you need a much higher return on the equity deal to get the same total return for you investors,” he said Rivollier.
REFINANCING RISK
Certainly, a handful of private equity houses have already become accustomed to such refinancing risks. Vista and Thoma Bravo are among private equity firms that have bought companies over the past 12 months with mostly equity funding, with plans to add debt to them later. They do this to avoid lengthy negotiations with lenders while rushing to close deals with sellers.
According to Dealmakers, one benefit of the shift towards equity financing is that companies owned by private equity firms have more cushion to absorb losses if their business deteriorates. Many of the leveraged buyouts that led to bankruptcies after the 2008 financial crisis were the result of private equity firms racking up debt on companies.
Jonathan Rouner, vice chairman of investment banking at Nomura Securities, said private equity firms have reserved the option of when to incur more debt for their companies if it is possible and safe to do so.
“You fund the investment with equity and when the funding markets recover, you do a big financing to get your equity back,” Rouner said.
(Reporting by Chibuike Oguh and Anirban Sen in New York; Editing by Greg Roumeliotis and Jonathan Oatis)
