The partys over

If ever there was a deal that illustrated the complexities and clout of the relationship between private equity firms and their investment banking partners, the £2.05bn dividend recap for UK retailer Debenhams is surely it.

Debt investors figure that Citigroup, CSFB, Merrill Lynch and Morgan Stanley and their seven sub-underwriters are long on Debenhams and that a quick sell-off by some of them may push the senior tranches three points below par. The prognosis for the second lien loan is 95 or even lower, although bond investors looking to re-book exposure could absorb some of the shortfall in the form of a repackaged note. Debenham’s existing bonds were taken out with the recap, so bond investors may wish to re-enter the name for less than arduous credit work.

In the case of Debenhams, the syndicate has put its balance sheet where its mouth is: firmly at the disposal of private equity clients that they hope will adopt a one-stop approach to capital markets business. They

have underwritten debt facilities to facilitate a further £800m dividend for Debenham’s private equity owners CVC, Merrill Lynch Private Equity and Texas Pacific. The unspoken quid pro quo is that the firms will turn to the banks once again if and when they decide to exit Debenhams through the public markets.

This kind of thinking is par for the course in the private equity/investment banking dynamic. Things only get interesting when the underwrite is not offloaded as much or as quickly as the banks were hoping. It looks like just such a scenario is developing on Debenhams. The underwriters must naturally provide support for their private equity clients and the investee company, even though their own balance sheet considerations may be telling them to reduce their position quickly in the market. They must also police a sensible sell-down among the sub-underwriters, some of which are also looking for a quick exit, according to debt investors.

It remains to be seen where Debenhams will break and how the sell down will be co-ordinated. Nevertheless, over-long exposures mean the arrangers have felt the bite of an aggressive structure. With other deals including Amadeus breaking below par, it could mean that the excesses of private equity’s debt-fuelled spending spree may be clipped for the rest of the year.

For the private equity firms, the result is no great disaster. They have already extracted £1bn from Debenhams and could go on to make more from a sale or flotation. On a positive note, the result means that private equity firms have also seen some upside at a time when banks’ fees from private equity clients have been rising considerably.