I-Banks Bridge Equity, But Could Get Wet

Over the past several months, investment banks have put up billions of dollars worth of what they hope will be temporary equity stakes in some of the largest LBOs in history, including the buyouts of Equity Office Properties Trust and TXU Corp. The big question for these firms is: What happens if they can’t later find buyers?

According to Paul Kingsley, a partner at law firm Davis Polk & Wardwell, equity bridges are a function of the need for speed in today’s competitive environment. Buyout firms have to move fast to close a deal—sometimes too fast to put together a complete buying consortium. In those cases, general partners are turning to their advisors and lenders to fill in the equity breach until a permanent buying team can be put together.

The Blackstone Group’s $39 billion buyout of Equity Office Properties, which closed last month, included a $3.5 billion equity bridge provided a laundry list of banks including BAS Capital Funding Corp., Bear Stearns Commercial Mortgage Inc., and Goldman Sachs & Co., according to an SEC document. Blackstone itself put in $3.75 billion of equity from its Blackstone Real Estate Partners V LP fund.

The more recent $45 billion agreement to acquire TXU Corp. by Kohlberg Kravis Roberts & Co. and Texas Pacific Group has a reported $1 billion equity bridge provided by Citigroup, JP Morgan and Morgan Stanley. The bridge compliments the deal’s $7 billion of traditionally-committed equity. Meanwhile, the take-privates of Clear Channel Communications Inc., HCA Inc. and Laureate Education Inc. also included equity bridges, according to an attorney familiar with their terms, although we were unable to independently verify those by press time.

Fees for equity bridges are charged up front, and tend to range between 1 percent and 2 percent of the investment bank’s equity commitment, according to Ilan Nissan, a partner at O’Melveny & Myers LLP. The buyout shops are often given the right to decide who the bank can and cannot invite into the syndicate in order to guard against competitors being invited into the deal.

Most of the time, the responsibility to syndicate the equity falls on both the general partner and the investment banks and is done over a period of about two to four months, Nissan said. However, some published reports suggest that the onus sometimes falls solely on the general partners to syndicate the equity. Likely buyers of the equity stakes include other buyout shops, hedge funds and even mezzanine players.

Sources said that investment banks have been willing to provide equity bridges in part to win the advisory and lending business from buyout firms. But doing so does carry big risks. Unlike bridge loans, which are secured high up in a company’s capital structure, equity bridges, like traditional equity tranches, are unsecured.

“What this portends is that at some point there will be a bridge too far, or a bridge to nowhere—pick your metaphor,” Kingsley said. “In one of these deals something will go sour and the sponsor will be unsuccessful in syndicating the equity to other buyout funds, and the bank lender will be sitting on a very risky investment.”

And it’s not just the mega take-privates that are being bridged low down in the capital structure. Nissan said he’s seen a number of private, mid-market deals with enterprise values of between $400 and $500 million making use of equity bridges. He declined to name specific deals.

There seems to be a natural cut-off for transaction sizes below the $400 million mark. “Small deals don’t lend themselves to the kind of cost and expense that you need to have in order to justify going through the complexity of putting in an equity bridge, getting the syndicate together, etc,” Nissan said.—A.N.