You cannot swap debt out and simply put private capital in

By Paul Mackintosh - 28/10/13
In a separate context this week, I picked up some insight into one opportunity for private equity in Asia. It’s one that has cropped up before in a further context of its own – the availability of bank financing (or not) in the region. Hitherto this has been brought up mostly as a problem for leveraged buyout (LBO) transactions, where the loan package that goes with such a deal becomes more expensive and/or fragmented – syndicated out across a greater number of providers and very probably incorporating a larger tranche of mezzanine debt. But it’s interesting to be reminded that the same issue has had a direct impact on corporate as well.
Basically, many banks that operate in Asia are still retrenching and deleveraging. This applies especially to some European banks that in some cases recklessly overextended themselves in the region, and in other cases are in meltdown or under new (and often state) management in their home jurisdictions – or once again, both. Some are reducing exposure, some are cutting entire business lines, and the story is still running. Asia’s own banks of course have jumped at the chance to cover the capital shortfall, but even so, corporate needs are running ahead of capital supply in the region. Hence the opportunity for private equity.
Loan funds have long been proponents of this kind of possibility. Their take on the market is that Asian companies are fundamentally more comfortable dealing with debt transactions than equity deals. They understand debt, they are familiar with how it operates in their capital structure, they see it as manageable and controllable. Private equity, in contrast, is less well understood and brings with it all kinds of awkward questions about dilution and control. Even in minority transactions, some Asian businesses still have an issue with giving away equity stakes. Especially when, in family-owned businesses from SME to conglomerate size, they would basically be giving away a share of the family’s own assets.
The loan funds have made the argument that debt is essentially an easier way into the capital structure of a typical Asian company than equity. Some private equity funds already operate more as minority-stake capital providers than on the classic LBO owner-operator model. But fundamentally private equity has to be building value in an investment. The equity stake is there to put skin in the game, and align the fund’s interests with management. Debt is a very different animal, and to view the two as equivalent sources of funding for cash-strapped companies carries potential risks and confusions. You cannot swap debt out and simply put private capital in.