Private Equity Doesn't Sleep, Debt Market Or No

February 25, 2008

Seems the signs continue to point to a private equity market that motors along (albeit at a much reduced velocity), getting deals done any which way it can, with credit agreements from investment banks, or without.

Back in November, we ran a story called "Cutting Out The Middleman?" Written by Matthew Sheahan, the article looked at flush private equity firms hunting down alternative sources of financing for their deals (HYR, Nov. 5, 2007).

Now it seems the trend of circumventing the credit markets is growing, according to a story in The Wall Street Journal, with PE shops increasingly calling on their own investors to chip in debt on buyouts. Firms such as Carlyle Group, TPG Capital and Silver Lake Partners say they have had to spend extra time recently lining up debt before heading to the bargaining table.

The tactic helps buyers lock in financing terms that are more certain than if they were to go to banks, according to the Journal piece. Realistically, banks can't guarantee final terms until they get investors to agree to them.

While the strategy isn't a new one for buyout firms, it's not hard to see how conditions in today's credit markets could cause an increase in its use. Obviously this is not good news for wounded investment banks, which have already lost out on billions in M&A fees because of the market's painful slowdown. A Bank of America analyst estimates that investment bank coffers ended 2007 with $4.4 billion less than expected because of withdrawn M&A deals. And banks have already seen $126 million of fees slip through their fingers this year because of M&A deals that werenever completed.

And it's not just beefy buyout firms that are bypassing the debt markets, according to the Journal article. The story points to the case of Fox Factory, a maker of shock absorbers for bikes and off-road vehicles. Apparently, talks to sell the company faltered when the credit markets ground to a halt and one PE shop backed out. However, Compass Diversified Trust, a publicly traded buyout firm, stepped in, offering a whole package of equity and debt. Compass got the deal, buying a 76% stake in Fox Factory for $85 million.

Clearly, a firm that can provide its own debt has an advantage when bidding for a company. Everybody likes a sure thing, so much so that the ability to close may even beat out price in some instances. And this leaves investment banks in the precarious position of having little to bargain with. -CJC

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