Buyout firms have no choice but to hold on

Uncertainty continues to prevail. With visibility on bank lending impaired until the new year at least, what could buyout firms be doing to invest their cash in the meantime?

Could they look to buy companies that are already geared?

This is not a trend anyone is expecting. In all but a minority of cases, a change in ownership would give lenders the chance to monetise their investments and with liquidity so tight at the moment the chance is that they’d take it.

Undertaking all-equity deals is another more widely discussed option.

The illiquidity is in the debt markets. Private equity firms themselves have substantial firepower due to the funds that they have raised over the past two years.

In October, Advent International bought the card processing activities of Experian France in what Pascal Stefani, head of Advent’s Paris office, called “an innovative deal, without debt financing . . . involving DocatPost, an excellent strategic player”. The deal weighed in at €203m.

Cinven bought annuities company Partnership Assurance for about €200m without debt in June. At the smaller end, August Equity completed a £20m equity-only deal when it bought a regional care home operator in the UK in early November.

“It is clearly easier to do equity only deals in the current environment,” said Aatif Hassan, who co-led the deal for August Equity.

But this by no means represents a rush to do equity-only deals. Buyout firms will only invest on a debt-free basis very rarely on certain opportunities for specific reasons. Yes, some equity-only deals have taken place, but no more than usually occur as part of general deal activity.

The buyout market is not going to see a flood of private equity firms essentially bridging their own debt to make acquisitions with a view to refinancing later.

The lack of visibility would-be borrowers have on when senior lenders will reopen for business means all-equity deals are far too high-risk.

Some funds would only be able to hold companies they have bought in equity-only deals for a short time after receiving special agreement from LPs, due to a diversification clause that states that they can only invest 10%–20% of the fund in a single transaction.

In today’s market, insecurity is such that few players would be willing to bet on significant debt being available at a reasonable price in the next six months.

Another factor mitigating against the debt-free buyout is the current economic climate.

Committing just equity to acquire a company would have been much more likely in the good times before mid-2007 than today.

Before the credit crunch, banks would have clamoured to lend to a company snapped up quickly by a buyout firm with only equity to ensure it won the deal ahead of its competitors.

In fact, European Capital’s model was based on the fact that it knew it could refinance post-deal. Where is the player that trade-marked “One-stop shop” today?

In addition, back then a buyout firm would be more inclined to transact quickly – all the information memoranda sent out showed companies with revenues and profits on an upward trajectory.

Conversely, buyers today find themselves in an economic slowdown, and possible recession.

Until they have some more visibility on a company’s 2009 earnings outlook, they are going to hold off investing unless they’ve found a standout, recession-proof business.

In Q4 2008, a quarter of such light deal-flow, who can forget that private equity is a long-term play? That’s why firms are waiting and not rushing out making equity-only commitments.

Plus, there’s that added concern, particularly for buyout firms that do larger deals, over the ability of investors to honour capital calls at present.

People are holding their breath, and they still have time to at the moment. Should credit continue to stay this contracted for the first half of 2009, the waiting game may give way to some rasher tactics.