News

Private equity firms buy undervalued companies, turn them around by cutting costs and raising performance, and then sell them on at a higher price, usually within five years.



That’s the theory. But the practice is increasingly different.



Just in the month or so up to mid-February, at least seven private equity-owned companies had filed for bankruptcy in the United States, according to a piece on The Wall Street Journal’s Deal Journal.



“Many of the companies have fallen victim to too much debt. And it’s not just debt borrowed to finance the original buyouts, but additional leverage used to fund bolt-on deals,” observes Deal Journal contributor Shasha Dai.



“It didn’t help that some of the sponsors behind the deals have cut their own fat checks by putting on more debt, in controversial transactions known as dividend recaps.” In a recap or recapitalisation, the private equity investors pay themselves a special dividend by having the bought-up company borrow more money.



Among the companies hitting the dust in the month’s bankruptcies were a furniture retailer, a car parts provider and a call-centre operator.



Most of the bankruptcies were of medium-sized companies, in part because bigger companies can use their extensive assets to borrow more.



But even big companies are finding that being owned by private equity can, by impairing their creditworthiness, make it more difficult for them to raise fresh money.



More than a third of the $131 billion worth of loans and bonds that rating agency Standard & Poor’s downgraded to junk (speculative grade) last year were issued by some of PE’s biggest portfolio companies.



S&P reported at the end of February that 13 out of 42 companies it downgraded to junk from investment grade were private equity-backed, according to Financial News Online US. These so-called “fallen angels” include leading 2007 buyouts: Canadian telecoms group BCE, US power utility TXU Corporation, and UK pharmacy chain Alliance Boots.



Financial News notes that analysts see such downgrades as “highlighting the aggressive financial model and weakened creditworthiness these companies are forced to run following their leveraged [debt-heavy] acquisition”.



For example, S&P said that TXU’s downgrade reflected the company’s plan to incur about $24.6 billion in additional debt.



Another sign of difficult times is the rising number of planned buyout deals that are not being completed or even being rescinded. UNI has already underlined the rising number of US private equity deals that failed last year.



And contrary to what transnational PE groups had hoped, emerging markets are not immune from the financial consequences of the industrialised world’s economic slowdown.



“Market meltdown hits PE!” cries an Indian headline over a report that last-minute brakes have been slammed on a number of deals. Plummeting Indian share prices have led to a widening gap between what private equity buyers are willing to pay for a company and what its sellers are willing to accept.



Observers say some ten large Indian deals have fallen through, and estimate that it could take months for sellers to adjust their expectations downward. Also, with less money to spend, foreign funds are insisting on “more financial discipline”.