In the break-out from the financial crisis, one of the much-debated issues has been whether the kind of private equity-sponsored initial public offerings seen before 2008 would ever make a comeback.
Although nobody’s predicting the imminent return of $50bn deals, two US flotations have gone some way to settling the issue. The IPOs of pipeline company Kinder-Morgan, which raised $2.9bn, and hospitals group HCA Holdings in mid-March, which investors rushed for nearly $2.8bn, reassured believers such as Kirk Radke, private equity specialist for 101 year-old global law firm Kirkland & Ellis.
For him, the flotations are a precursor of even better things to come. “Those IPOs validated the private-equity investment thesis and will go a long way to answering the questions in investment committees,” he told the magazine. “They are a very important part of the whole capital markets story because they show that equity markets are open and that this size of transactions can be done.”
The HCA float, in particular, astonished observers. Sponsored by Bain Capital and KKR, the Nashville, Tennessee-based group was expected to attract prices of around $27 for 124m shares. Instead investors snapped up 126.2m shares at $30, prompting optimism among market-specialists such as Bill Buhr, IPO stategist at Morningstar. “If you can price a $3bn deal for a hospital operator that has a few warts and so successfully, there are lot of [other] deals that could be done right now,” he told Reuters.
The hospitals group, which was taken private in 2006 in a $21bn buy-out, does indeed have a few warts in the form of heavy debt but the market has clearly discounted the burden in the prevailing environment of low interest rates.
But how much higher can these deals go? According to market insiders, $15bn is currently practicable at a debt:equity ratio of 2:1. “You need two things – debt and equity markets with that kind of capacity,” adds Mr Radke, whose firm is the 11th largest practice in the world by revenues with clients such as Samsung Electronics, Siemens AG, General Motors and BP.
The omens are promising. According to sources, David Bonderman, founding partner of TPG Capital, recently told a private-equity conference in Europe that transactions based on $10bn in debt could be mounted in the US, albeit in the club deals that will probably become typical of the rebound from the crisis. In general Mr Radke agrees with this prognosis: “These transactions can be put together in consortiums – the confidence is there – but the big question is where exactly are the US equities markets at? We’ll know that in coming months.”
As the fund-raising season gathers pace, with firms queuing up to tap sources of finance, the next big question will be put. Namely, exactly which private equity houses have emerged from the crisis with their reputations damaged, intact or even enhanced. “Exactly who will be successful in the coming year is the big question,” predicts Mr Radke. “That will tell us a lot about the new market.”
The total amount raised by the industry as a whole will also tell us a lot, particularly after last year when funds dried up. Just $225bn was raised globally in 2010, less than a third of the $700bn accumulated in 2007 and 2008, and the lowest annual total since 2004. Although giant buy-out firm Blackstone was able to raise $15bn for a new fund earlier this year, that was considered something of an aberration because most of the money was in the pot before the financial crisis. However a continuation of low interest rates in western markets is seen as nothing but helpful.
What’s good for America may also be good for Asia. Mr Radke’s latest annual fact-finding tour of the region’s capitals has convinced him that Asia could be ripe for an explosion of private-equity deals, albeit on its own terms. “The mood in the banks, sovereign wealth funds and other firms I spoke with was very positive. They are very aware of how the private-equity model adds value to portfolio companies,” he reports.
Investment in the region is occurring on three levels. “It’s local, regional and global,” he adds. “New regional funds are emerging in countries like Korea and Indonesia. Most of these are country-specific but they’re also very forward-looking. For instance, Korean investment professionals are looking at opportunities in their own country but also in the wider world. Overall the confidence of investors in Asia is much stronger than it was when I visited last year.”
In that wider world, yet another reason for optimism is the surprising re-emergence of less restrictive borrowing terms known as covenant-lite. Almost demonised by critics in the wake of the financial crisis, “cov-lites” get their name from the softer covenants contained in the fine print that gave more freedom to borrowers. Hardly any cov-lites were written in the last, highly risk-averse 2.5 years.
However, they are making a comeback across the board, not only in new deals but also in the refinancing of existing debt as borrowers seek more flexibility in conditions. So far this year, American companies including retailer J Crew and food group Del Monte have issued some $17bn in cov-lite loans. Although that’s way down on the $100bn written in 2007 alone, it’s a sign of a thaw in extreme risk-aversion.
For Mr Radke, this can be taken as a feather in the cap of the private-equity industry — an acknowledgement by lenders of its generally robust performance during the crisis. “It’s happening in new and old transactions,” he explains. “As clients retool their existing debt, more and more packages are being written under cov-lite terms. Cov-lite loans come with incremental increases in interest rates but they aren’t prohibitively more expensive than covenant-heavy packages. “
The less onerous terms make sense for both sides. Buyers are attracted to the additional yield and are happy to give up a measure of control in return, while private equity appreciates the extra latitude in the way it manages portfolio companies. And very importantly, as the industry holds these companies for generally longer terms than it did before 2008, it also permits private-equity owners to take a more strategic view and deal with unforeseeable events.
Indeed it may yet turn out that cov-lites function better than their covenant-heavy cousins. According to research by Citigroup, the cumulative default rate since mid-2007 for cov-lite debt is almost half that of regular leveraged loans.
