The New Face of Capitalism
Private buyers are gobbling up some of the premier names in corporate America
Many investors did stay away from the Hertz IPO. The company went public November 16 at a lower price than was expected and then barely budged off its $15 offering price. But it was still a sweet deal for Carlyle and the other private-equity firms involved. They are expected to have doubled their money after having owned Hertz less than a year.
Party poopers. So, what will spoil the private-equity party? If returns begin to suffer because of competition, unhappy investors could slow their stampede into the funds. Hints of other frauds could have the same effect.
But the real bogey is the debt markets, because borrowing underpins private-equity firms' ability to make many deals. Any sudden upward move in interest rates could inflict serious pain in the buyout world. Right now, lenders, competing heavily to be part of deals, are giving easy payment and loan terms that could help forestall any default of a company owned by private equity if it got into financial distress. But these lenders are also allowing private-equity firms to take on buyout loans that represent ever-higher multiples of earnings.
Some buyouts are also adding newer and more risky types of debt to the mix, as they offer up more and more of a company's assets and earnings to secure it. Second-lien loans and "payment in kind" notes, which have yet to be tested in a severe economic downturn, have become popular. The notes pay extremely high rates but usually don't begin payments for several years and are likely to become worthless in any bankruptcy.
A few private-equity-owned companies have already had trouble, and some have filed for bankruptcy protection. Concern about the increased risks being taken in new deals is becoming increasingly palpable in bond and derivative markets. For instance, when Anheuser-Busch was rumored to be a private-equity target, the cost of buying credit protection on its bonds rose drastically.
A shakeout is coming, experts say. It is just a question of when. Many banks, law firms, hedge funds, and private-equity groups are already bolstering the ranks of their distressed-debt units and are gathering bankruptcy specialists for just such an occasion. Private-equity player Wilbur Ross, known for his astute nose in picking up distressed companies on the cheap, says it won't be long. Too much money is being paid to take on too much risk with too much debt, Ross warns, adding that bets by some highly leveraged buyout firms that they will be able to cheaply refinance their deals in a few years have "been building in a time bomb." In this scenario, higher default rates aren't just likely, he concludes; "they are quite inevitable."
If Ross is right, many private-equity firms and the companies they take over may find the 1980s have cast a longer shadow than any would have hoped.
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