PE players morphing into banks
By Paul Mackintosh - 15/10/12
Talk to any buyout sector professional in today’s market, and the conversation will likely revolve round to leverage finance, whose scarcity value rivals oil or rare earths as a concern in the leveraged buyout (LBO) community. Well, that was exactly what I did in Europe this week, and learned something of the latest innovation to supplement or replace increasingly scarce senior bank debt in buyout deals: debt funds.
To some extent, this is nothing new. The Carlyle Group is just one of the major private equity houses to diversify into this business, raising debt funds that could in theory fuel the deals of its rivals in the buyout space, and closing its latest Collateralised Loan Obligation (CLO) fund in September this year. But the compromised asset bases of many banks worldwide and the pressures of post-Dodd-Frank regulation on their non-core investments have given a boost to alternative providers of products that display characteristics similar to senior debt in terms of capital structure. The debt itself is still pricier than senior debt, and has some mezzanine-style equity kicker components included, but it can be raised readily and earns fund limited partners (LPs) around an attractive 18% gross.
These funds, in their US form at least, are individually below US$100 million for regulatory reasons, to keep them below critical oversight thresholds. But they can be raised readily in bulk, and corralled together to invest into deals – in the kind of complex structure that financial and legal advisers love to reap fees from. From the end-user’s point of view, their debt is less dilutive than full mezzanine or straight private equity investment, making them attractive to some corporate borrowers, while being cheap enough to still attract buyout general partners (GPs) as well. Their LP base is the usual spread of pension funds, insurance companies, asset management groups, foundations, and other staples of the Western fundraising circuit, with perhaps a bias towards high net worth individuals, who value their predictable and high return, and their relatively protected position in the capital structure. Conceivably, they could be taken above the $100 million size if demand is strong enough to merit the additional compliance burdens, but for the moment, they are doing very nicely.
Could such a model thrive outside the US? Conceivably, European and even some Asian banks are also challenged post-crisis, and interbank lending pressures ensure that senior debt remains expensive everywhere. But this whole development also plays into the thesis that major private equity firms like Kohlberg Kravis Roberts, Carlyle, TPG and the others, as they list themselves and acquire more and more assets, are mutating into Goldman-style multi-strategy financial groups. In this scenario, there is clearly room for them to become more like the banks.