Rush to avoid defaults

Defaults and the breaching of covenants are increasingly coming back to haunt leverage buyout groups in 2009. January kicked off with ostensibly publicity-shy global private equity firm BC Partners taking the unusual step of announcing to the press that its portfolio company Foxtons had breached performance terms set by lenders Bank of American and Japan’s Mizuho.

BC Partners also said that its Swedish luxury boat fittings business Dometic was set to breach its banking covenants soon, with bank negotiations due to begin shortly. Also in 2009, Candover is facing pressure from a banking syndicate, led by Royal Bank of Scotland and Mediobanca, regarding its yacht building business Ferretti defaulting on its €1bn-plus debt.

The situation comes just months after Candover ditched a planned flotation of Ferretti, which it bought from Permira for about €1.7bn in October 2006.

Nordic private equity house EQT has been negotiating with lenders in its buyout of bathroom manufacturer Sanitec, with reports suggesting that it has offered to put in a further €100m of equity in return for a €500m reduction of the company’s debt burden.

US-based TPG Capital, a significant loser in 2008 following disastrous bets on Washington Mutual and Harrahs, has been in negotiations with JP Morgan and UBS regarding a potential covenant breach of its European chemicals business British Vita, bought for £668m in 2005.

Apax Partners France’s fashion brand Morgan, filed for bankruptcy protection in late December, despite having spent much of the year on the auction block. Staying in France, PAI Partners’ house building businesses Monier and Kaufman & Broad are also facing problems.

“If you have been doing any private equity deals in the last three years, it would almost be quite difficult not to have some defaults,” said one private equity lawyer with knowledge of the issues.

“With the number of big deals done between 2005 and 2007 there has got to be a chance that there will be an issue somewhere, especially given the large amounts of leverage going in and adverse trading conditions currently.”

At a recent private equity conference organised by the London School of Economics, Alchemy Partners’ Jon Moulton warned that almost a third of companies owned by UK mid-market private equity groups could default on their debts in the current recession. Moulton drew a parallel to the last recession in the early 1990s, when he said receivership was the most common and most valuable form of exit from private equity deals.

Andrew Newington, a partner at BC Partners, said that Foxtons was trading profitably, with strong lettings flow accounting for approximately 50% of revenues, but its fate was now in the hands of the banks. “As housing markets fall, so do estate agents, so we got that wrong,” he said.

BC Partners is reluctant to inject further cash into Foxtons until Bank of America and Mizuho can agree to write off some of the firm’s £260m debt. Newington said that his firm “would be prepared to back a capital structure more suited to the current environment”, having put £50m into the original buyout, alongside a £50m loan from Foxtons founder John Hunt, putting the total price at approximately £360m.

Newington criticised the level of scrutiny of its investment, noting that it represented just 1% of the firm’s committed capital. In the past, BC Partners has also had to write off its investment in US-based auto parts supplier Mark IV, a 2000 deal in which the firm allied with co-investors including Ontario Teachers’ Pension Plan in a US$2bn acquisition. Last July, UK BC Partners and Electra entered negotiations with banks regarding their co-investment in Baxi, a UK boiler marker.

“Private equity-backed firms are more highly leveraged than other private enterprises, so there is less room for manoeuvre than a less aggressively structured package,” added the lawyer.

“It is certainly more sensitive to trading changes. But in fairness, this is a pretty black time and, although in hindsight you could see it coming, people were not predicting it would be as bad as it is, even this time last year.”