PE Week Wire: Thursday, October 9, 2008

Not to fear monger, but here’s some scary math: Special situation pros are predicting default rates will eventually hit between 5% and 8%. That’s pretty high, considering that right now the 12-month trailing default rate for speculative grade debt is 2.68 percent. Year to date, 60 of the 2,238 US companies tracked by S&P are in default. Out of those 60, 22 are backed by private equity firms. That means more than a third of all companies in default are, depending how you frame it, “victims” of leveraged buyouts.

If the default rate does indeed rise to even 5% by year-end, and the LBO ratio remains stable, then it could mean 111 more buyout-backed company defaults. Note that the number of buyout-backed defaults (22) is much lower than the number of Chapter 11s (39).

The only saving grace is that most people I speak with believe the real bloodbath will hold off until the first quarter of next year. By that time, the highly-leveraged, covenant-lite, ‘06-‘07 mega-buyouts will have had enough time to ripen, decay and rot. .

Thus far, the ’08 buyout-backed defaults have deal values below $5 billion. Do turnaround experts expect a mega-buyout bankruptcy in Q1? “Certainly,” said Mo Meghji of Loughlin Meghji + Co., a restructuring advisory firm. Not only are the big LBOs finally coming of age, they have dangerously loose covenants. Beyond that, Meghji said, for the past year or so, sponsors and companies have been drawing down their revolvers as a way to stem the tide. This is a trend not seen in prior downturns. That liquidity option will dry up soon enough, too.

Lorie Beers of KPMG’s Special Situations agreed that people seem to be holding their breaths for a giant wave of defaults in Q1 of next year. “The 12 to 18 months after that will be a very bumpy ride.”

About Those Bank Holding Companies

On Monday, peHUB reported that there are at least three private equity firms capable of taking control stakes in banks, because they’re structured as bank holding companies. One of them, Castle Creek Capital, happens to be in fund-raising mode.

I’ve learned that the firm is seeking $500 million for its fourth effort. Fund-raising launched in June, and its first close is scheduled “by the end of the year,” a source said. With its distressed/turnaround focus, and strict financial services sector mandate, Castle Creek could not be better positioned to take advantage of the current environment. A position that, I argued on Monday, could afford it opportunities to partner with some larger PE firms. The idea is the PE firms may want to buy into distressed financial companies, but are stuck in the minority stake ghetto because of federal regulations.

However, yesterday I learned that Castle Creek does not have a history of partnering with private equity firms and isn’t likely to embrace the strategy now. So follow my thinking here: There are only a small number of PE firms that can take control stakes in the growing pile distressed banks. Not many PE firms want to take minority stakes in banks, because (A) Look what happened to TPG, and (B) Who wants a minority stake in a turnaround anyway? You may as well play the stock market. And finally, PE firms are basically the only guys in finance right now with a ton of money and not a ton of places to put it. So, if Castle Creek isn’t so hot on partnering with PE firms to try and help out a few struggling banks, what’s a firm to do? Methinks $500 million is not going to cover the many regional banks and thrifts in need of help out there anyways. Furthermore, Castle Creek invests in asset managers with between $100 million and $5 billion under management.

By the way, Castle Creek has been around since the late 90s, when it raised its first two funds. Those were wound down right before the buyout boom launched, when, a source said, “the world started to change.” So Castle Creek headed back out to market. Well, the world is certainly changing again, so maybe Castle Creek will evolve with it.

There’s also Belvedere Capital, another bank holding company PE firm. I’ve gathered that Belvedere is more open to partnering with PE firms to take over financial services companies. Unfortunately, Belevedere’s focus is not explicitly turnaround/distressed. Belvedere has just launched its own fund-raising efforts, with a $500 million target for its fifth fund.

Top Three

Linens ‘N Things, the bankrupt home goods retail outlet owned by Apollo Management, has asked for court approval to liquidate.

MBK Partners has agreed to invest $2 billion in South Korean infrastructure projects, businesses and property, according to the country’s National Pension Service. The pension fund is in talks for another $3 billion deal with an unnamed US-based asset manager, Reuters reported.

VC Deals

ReverbNation, a marketing and promotion technology platform for the music industry, has raised $3 million in Series B funding. ETF Venture Funds led the round, and was joined by return backers Novak Biddle Venture Partners and Southern Capitol Ventures. ReverbNation has offices in New York and Raleigh, N.C.

Orthoscan Inc, a Scottsdale, Ariz.-based medical device company, has received $7.5 million in Series B funding led by River Cities Capital Funds, and including investments from Aphelion Capital, California Technology Ventures and private individuals.

AgileNano, a San Diego-based medical technology developer, has closed an undisclosed Series A round of financing from San Diego Tech Coast Angels.

Apieron Inc., a Menlo Calif.-based medical device developer, is raising $25 million in Series D funding, LBOWire reported. The firm has received venture backing from Onset Ventures and Alliance Technolog Ventures, as well as Canaan Partners, and Draper Fisher Jurvetson.

OwnEnergy, a wind energy developer based in Brooklyn, has secured Series A financing of an undisclosed amount from EnerTech Capital Partners, Contour Venture Partners and the New York City Investment Fund, according to reports. OwnEnergy site

Buyout Deals

Sun Capital has completed its acquisition of Kraco Enterprises, a Compton, Calif.-based maker of automotive aftermarket floor mats. The deal value was not disclosed.

PNC Equity Partners has recapitalized portfolio company Tangent Rail Corporation for the third time in its ownership. The Pittsburgh-based railroad maintenance company was purchased in 2005.

Corinthian Capital, a New York-based buyout firm, has invested in Precision Motor Transport Group LLC, an Okemos, Mich.-based automotive transport services business for luxury automobile carriers. Deal terms were undisclosed.

Sverica International, a buyout firm located in Boston and San Francisco, has purchased Accuvant Inc., a security services technology company. The deal included a $20 million revolving credit facility and $4 million term loan, provided by PNC.

AXA Private Equity has increased its stake in Carbone Lorraine, a publicly traded France-based materials maker, to greater than 15%. The investment was made through Axa Capital Fund L.P.

American Industrial Partners is having discussions to acquire Mark Andy Inc, a St. Louis-based printing equipment company, from Morgenthaler Partners, Buyouts reported. American Industrial Partners is a New York-based LBO shop.

Baird Capital Partners has backed the MBO of Medical Education Technologies Inc, a Sarasota, Fla.-based learning software company. The company’s founder and CEO, Lou Obernorf, participated in the buyout.

Monomoy Capital Partners, a New York-based turnaround firm, has acquired the Molded Products Group of Atlantis Plastics Inc. for $27 million in cash and the assumption of $7 million in liabilities. The company has $110 million in revenues. Monomoy plans to combine the business with L&P Plastics, another carve-out the firm completed in recent weeks.

PE Exits

Oracle has agreed to acquire Primavera Systems Inc., a Bala Cynwyd, Pa.-based provider of project and portfolio management software, from Insight Venture Partners and Francisco Partners. No financial terms were disclosed. Insight and Francisco sponsored a recapitalization of Primavera Systems in 2006, and reportedly committed up to $200 million in combined equity.

MessageLabs, a UK-based security services provider with backing from Madison Dearborn and Catalyst Investors, has sold to Symantec Corp for $695 million. The company raised at least $58.9 million in funding, including $36 million from Catalyst and Madison Dearborn in 2000.

Linens ‘N Things, the bankrupt home goods retail outlet owned by Apollo Management, has sought court approval to liquidate.

PE-Backed M&A

Integrated Broadband Services, a Kennesaw, Ga.-based software and services business backed by Wachovia Capital Partners, has closed its acquisition of Parasun Technologies from Uniserve Communications Corp for an undisclosed amount. Parasun is based in Vancouver.

Apollo Management will provide $540 million to Hexion to help is close its merger with Huntsman. The disputed buyout was ordered to be completed despite the bidding parties’ argument that the target had suffered a material adverse change.

Intoto, a software platform product provider based in Santa Clara , Calif. , has closed its deal to be acquired by Freescale Semiconductor, an Austin, Texas-based semiconductor manufacturer owned by Blackstone Group and TPG.

Firms & Funds

Goldman Sachs has closed its first ever senior debt fund with $10.5 billion in commitments.

MBK Partners has agreed to invest $2 billion in South Korean infrastructure projects, businesses and property, according to the country’s National Pension Service. The pension fund is in talks for another $3 billion deal with an unnamed US-based asset manager, Reuters reported.

Elysian Capital, a new UK-based buyout firm, has launched fundraising efforts on its first fund, which has a $345.7 million target, LBOWire Reported.

Providence Equity Partners has launched fundraising for a new mid-market buyout fund with a $1 billion target, LBOWire reported. The fund, called Providence Global Growth Fund LP, will target companies requiring less than $150 million in equity per deal.

Human Resources

Erin Bogorad has joined fund-of-funds manager RCP Advisors as an associate, with a focus on due diligence and portfolio monitoring. She previously was with Wachovia Capital Partners.

Timothy Hartnett has been appointed U.S. Private Equity Leader at Pricewaterhouse Coopers. He fills the role left open by John P. McCaffrey, who has been promoted to leader of U.S. Transaction Services group at the firm.