Club buyouts

Club or consortium deals, in which two or more private equity houses come together to acquire a target company, have become increasingly common in the last couple of years. Among the main reasons for the trend are that clubbing together allows individual private equity houses to acquire much bigger assets than they would on their own and many club deals are for target companies worth over US$1bn.

One of the key deals that illustrated the change was March 2005’s acquisition of SunGard Data Systems in the US for US$11.3bn by a consortium of seven private equity firms, which became the largest LBO since KKR bought RJR Nabisco in 1989.

In Europe too the club trend has taken off in a major way. To take one example, Spain. In the past year or so most of the large deals have been club transactions, with a consortium including Providence, JPMorgan and trade buyer Ono acquiring telecom company Auna’s fixed-line assets for €2.4bn, BC Partners and Cinven coming together to purchase travel reservations company Amadeus for €4.3bn, and clothing company Cortefiel going to a club including CVC Capital Partners, PAI Partners and Permira for €1.4bn. It was only a very high €10.4bn bid from France Telecom that prevented private equity consortia from acquiring mobile phone company Amena.

In Europe barely a day goes by without rumours of one private equity consortium or another considering a bid for a major corporate. Among the latest is the news that a seven-member consortium, including Blackstone, Cinven and KKR, is considering a counter bid to the US$13.4bn offer by a trade buyer for Portugal Telecom. If this were to succeed it would be the largest ever LBO in Europe, well above the US$12bn paid for telecoms company TDC Denmark in November 2005.

It is worth remembering, in this context, that club deals have been consistently popular in venture capital, although their role in private equity has been more cyclical. In the early 1990s club deals in private equity were often formed in order to bring in houses with specific knowledge of an industry or other expertise. But from the mid 1990s individual funds became bigger and were more able to go it alone until a couple of years ago when the cycle changed again and competition for targets encouraged firms to band together to access larger target companies.

For private equity firms the main advantage is that clubs allow them to pursue bigger targets. This is because most funds are restricted to investing a certain percentage in any single deal, often 15%. What this means is that even though funds are getting bigger it is still often not practical for a single fund to acquire a large target alone.

“The equity cheque for companies like TDC or Portugal Telecom is simply too big for a single house,” says Chris Bown, head of the private equity team at law firm Freshfields.

As private equity generally has become more competitive and ever-larger sums are raised from institutions it has got harder to identify targets. Clubbing together means funds can widen the pool they fish in and thus deploy their capital. “As the market has got more competitive, funds are looking for new targets that have not been on their radar before and one of these is large cap companies that can be acquired through clubs,” says David Sheldon, a partner at law firm Fried, Frank.

Andre Jaeggi, managing director of fund-of-funds Adveq, agrees: “An important feature of syndication is the increased deal scope for participating funds. It enables them to access much larger deals than when they invest individually.”

Another benefit of consortia put forward by supporters is that because clubs bring together several players they effectively reduce the competition for assets, which means the target company can be acquired more cheaply. “Club deals, especially when several managers regularly do deals with each other, can result in better price discipline in the marketplace because the likelihood of them outbidding each other decreases,” says Adveq’s Jaeggi.

A third benefit is that club deals allow the private equity firms involved to share the risk of a particular transaction, which can be attractive when very large sums are at stake. Fourth, club deals can allow the members of the consortium to draw on each other’s expertise and thus benefit collectively. “We particularly like club deals in which partners are brought in to add value because of their expertise in, say, a particular industry,” says David Currie, managing director of Standard Life Investments Private Equity.

These arguments all have legs, but some argue it is not always the case that LPs’ interests mesh smoothly with those of private equity houses. There is also some dispute about the extent to which some of the benefits put forward for club deals actually materialise in practice.

Take the claim that consortia bidding puts downward pressure on the prices of large cap assets. Freshfields’ Chris Bown supports this view to some extent, arguing there are good competitive reasons to band together and it is better for a private equity fund, and its LP investors, to win a deal as part of a consortium than to go it alone and lose the deal. He says: “There are a limited number of players with the industry understanding, sector expertise and firepower to do the very large deals and it makes sense to get part of a deal in combination with others, than to come second and get nothing.”

But Dan Kjerulf, a director at Danish fund-of-funds Danske Private Equity, says club deals are not the only way of keeping prices of assets under control: “In the mid market there’s an understanding between funds that fish in the same waters that they will not bid each other up too much; there’s market discipline.” He adds this kind of discipline is perhaps less evident in the large cap market because of the huge sums available to private equity funds.

There is a view that club deals can lead to upward price pressure on target companies, rather than cheaper valuations. Hamish Mair, who heads the fund-of-funds business at F&C Asset Manager, says one danger when there several funds bidding for an asset is that pricing discipline begins to slip. “There’s a risk that because you’re sharing costs you start to think you can go a little bit higher on the overall price because you’re only paying part of it, and that’s why being disciplined on price is crucial.”

But probably the main doubt among LPs when it comes to club deals is their effect on risk diversification. While for private equity firms it can make sense to share some of the risk in a very large deal, for LPs it can have the opposite effect as they may find themselves invested in two or more of the participating funds and thus ending up with a much higher exposure than they would prefer. Andre Jaeggi says: “From the LP perspective, investors should be aware that they might get similar portfolios when several funds they are invested in participate in the same deals. As such, syndication could offset the benefits of diversification.”

Dan Kjerulf says: “You can talk to some LPs and they say they have a shareholding in company X in their public portfolio and that two private equity consortia are bidding for the company and they have investments in two of the firms on one side and three on the other. It’s understandable why some institutional investors feel frustrated at times.”

But not everyone is concerned on this score. Standard Life’s David Currie says he understands the risk diversification claim, but says: “The way we construct our portfolio means we’ve never been over exposed as a result of club deals.”

According to Michael Newell, an associate at law firm DLA Piper, it would be difficult for LPs to negotiate conditions restricting the GP’s involvement in club deals. The bigger funds would probably resist such “excuse provisions”, he says: “There’s much more investor power at the smaller end, in venture, than when you’re dealing with the large buyout funds,” he says.

Freshfield’s Bown believes, aside from the risk diversification issue, club deals are generally likely to be positive for LPs, and he widens the traditionally understood scope of such transactions to include what he calls “consortia of convenience”. These are club deals in which firms join together to acquire assets for other reasons, such as they are interested in different bits of the target company. By way of example, he points to Compass Group’s sale of SSP, its specialist travel concession catering business, to Macquarie Bank and EQT in April. The £1.8bn (US$3.4bn) deal was structured so SSP’s UK motorways business would go to Macquarie and the remaining airports and railway business to EQT. The rationale behind the deal, says Bown, was that Macquarie’s investment approach was more annuity based, while EQT has a more typical “build and sell” private equity approach, and the two parts of the target company suited those different models.

Anti-trust issues can also influence a deal and make it more attractive to have two or more participating funds, he says. For example, the structure of the acquisition last September of Norwegian explosives company Dyno Nobel was impacted by anti-trust considerations. Macquarie Bank led a consortium including Australian explosives company Orica, which acquired Dyno Nobel for US$1.7bn. As Dyno Nobel was the number two explosives company in Australia and the number one in the US, it could have been problematic for Orica to acquire. The transaction was structured so Dyno Nobel would be split into two entities, with Macquarie acquiring the US and Australian assets and Orica acquiring the assets in the rest of the world.

According to Bown, there is no reason for LPs to have any concerns about these types of club deal, as the roles of the participating funds are clearly defined and make business sense.

But as for the more typical club deal, it is harder to come to a conclusion, say some LPs. Dan Kjerulf says: “Our strategy is to avoid large cap funds, partly because of the prevalence of club deals. “If they go well everyone takes the credit and each of the funds goes round telling everyone it was their choice of chief executive, their great relationship with management and their strategy that make the deal a success. But if they go badly nobody wants to take responsibility.”

In the mid market Danske Private Equity has been even more wary of club deals than it would be among the larger funds, says Kjrerulf. The firm’s approach is one of seeking “hands on” private equity funds, he says: “How can you be hands on if you have five funds on one side of the table and the chief executive on the other? The risk is that he will divide them and fill the power vacuum, rather than having the clearly shared objectives between both parties that is crucial to successful private equity.”

Kjerulf is highlighting the suspicion among some LPs that in club deals it is easier for decision-making responsibility to be blurred because there are so many participants, and that there can be problems if things go wrong.

But LPs like David Currie at Standard Life are fairly relaxed about the trend. “We coinvest, so we’d actually prefer some of these syndicates to approach us to participate rather than other private equity funds, although I appreciate that not many LPs would be able to put in the £250m that some of these club deals require.”

Bown acknowledges putting together such club deals can, in itself, be a major undertaking. “They’re difficult and time consuming to put together and

you can multiply the difficulty

by the number of participating funds,” he says. Aside from the technical challenges in putting together such consortia, there is

the issue of ego clashes between individualistic private equity directors. Such clashes could become destabilising if a club deal were to go seriously wrong and participating funds disagreed on the solution. That has not occurred in a high profile way so far, but if it did the image of club deals would be severely tarnished.

Sheldon of Fried, Frank says: “If a club deal went badly wrong and there was a falling out of funds that would be very bad news, but I think that is unlikely because we’re talking about very sophisticated individuals at the top of these funds.” He adds that in each club deal there is an understanding, which is reflected in the documentation, about who control rests with if problems were to develop. The participating funds know where the balance of power lies in the club deal, says Sheldon.

Some funds that suspect they may have problems in a particular club deal will pull out before the deal happens, rather than stay in and find they are unhappy later on. Sheldon notes that, for example, in the recent consortium bidding for VNU one of the participating funds pulled out. “It’s far better they withdraw at the pre-transaction stage than have problems further down the line,” he says.

While there are arguments for and against club deals, Hamish Mair of F&C says it is hard to make generalisations and that each deal must be looked at on its own merits. There are some deals in which a private equity firm thinks the price is too high or that the leverage is excessive and so tries to persuade other funds to share the risk. “Obviously, in that case an LP would be concerned,” he says.

Much will probably depend on the returns made for investors by the current crop of club deals. Bown says it is early days to judge the success of club deals but that a couple, Eircom and Debenhams, have made successful exits for their investors. “Both those businesses performed better than planned, with both recapping first and then exiting. But as for the rest of the club deals, we’ll have to wait and see. The real test will be if one does not go to plan and whether, in that case, the participating funds can agree on who is in control and how to proceed,” he says.

For Currie, the key test will be working out who, in the successful club transactions, was really responsible. One of the reasons they fell out of favour in the 1990s, he says, is that every firm in a club deal was claiming it was behind the success. “Now that club deals are back, when these firms are next fundraising we’ll have to try and look carefully at these deals and work out who was really responsible for what,” he says.