By Miriam Gottfried
U.S. private-equity firms, armed with a record amount of cash,
are struggling to find ways to spend it.
A year ago, fears of an economic slowdown and worries about
trade tensions with China sent a tremor through markets and put
some leveraged buyouts on hold. But while stocks rebounded in the
new year, buyout activity never fully recovered.
The aggregate value of U.S. buyouts fell 25% year to date
through October, compared with the same period a year earlier,
according to data provider Preqin. Deals totaled $155.2 billion
during the first 10 months of the year -- the lowest since
2014.
Private-equity firms traditionally seek to buy up companies they
see as undervalued, cut costs or spruce them up to spur growth and
sell them or take them public a few years later. With U.S. equity
markets surging, already expensive takeover candidates have gotten
even pricier, making many of them too rich for even the most
optimistic private-equity buyer. Meanwhile, would-be corporate
acquirers whose stock prices have run up this year can use their
shares as a deal currency, giving them an edge over financial
buyers in most auction processes.
The restraint buyout firms are showing suggests a level of
discipline that wasn't present during the last market peak in 2007,
when they struck $365.9 billion worth of deals in the U.S. Many of
the companies they bought then struggled during the ensuing global
financial crisis, and a number have filed for bankruptcy
protection.
The drop in deal activity comes as private-equity firms' unspent
cash dedicated to North American buyouts reaches a record $771.5
billion, up nearly 24% since the end of last year and more than
double where it stood at the end of 2014, Preqin data show.
A potential buyout of Walgreens Boots Alliance Inc. that KKR
& Co. had considered in recent months shows some of the
challenges facing private-equity firms. Financing such a deal would
always have been tough given Walgreens' market value of more than
$50 billion, but the math has become even more difficult as loan
buyers have begun pushing back on what terms they are willing to
accept. The parties haven't been in the same ballpark on valuation,
and no deal appears imminent, people familiar with the matter
said.
Investors such as pension funds, sovereign-wealth funds and
insurance companies have poured money into private markets in hopes
of achieving higher returns than those offered by traditional
stocks and bonds in an era of low interest rates. Private-equity
firms will need to invest that money to satisfy their investors and
to begin earning lucrative management fees on it.
U.S. buyout volume may not bounce back next year either, even if
the stock market cools off. With an election looming,
private-equity investors say uncertainty around monetary, fiscal
and regulatory policy -- as well as already heightened scrutiny of
their industry from Democratic presidential candidates -- will
cause them to tread carefully.
Some firms have found unique ways to navigate high prices.
Blackstone Group Inc. has focused its deal making around investment
themes where it is particularly bullish. These include the growth
of e-commerce, which has driven its massive purchases of warehouse
portfolios, and the ongoing value of live entertainment as more
activities move online, motivating its deal for theme-park operator
Great Wolf Resorts Inc. Apollo Global Management Inc. has been
buying public companies it thinks the market has undervalued by
favoring those with faster growth.
Not all areas of the buyout market have slowed. Globally, deal
volume is pacing roughly where it was last year. And certain
pockets of the U.S. market remain robust. Firms that invest in
business software, for example, have kept up their deal-making
pace, thanks in part to the proliferation of targets.
"In our space, given that many companies lack profitability,
they can be highly volatile," Orlando Bravo, founder and managing
partner of software-focused firm Thoma Bravo LLC said in an
interview. "So when their revenue growth slows or they miss
numbers, that can provide opportunities."
The buyout malaise has spread to banks, whose revenue from
leveraged finance fell nearly 19% year over year in the first three
quarters of the year, according to Dealogic. New issuance of
leveraged loans -- commonly used to finance buyouts -- have
tumbled. High-yield bond issuance, another source of deal
financing, has climbed, but bankers say much of that has been
driven by less remunerative refinancing activity.
Making things more difficult for private-equity firms, the
financing market has tightened in recent months. As interest rates
have fallen, there have been big outflows from mutual funds that
purchase buyout loans that banks carve up and sell. That has made
deal financing more dependent on collateralized loan obligations,
or CLOs -- complex vehicles that buy bundles of
below-investment-grade corporate loans.
CLOs, which have historically constituted about 60% to 65% of
the market for buyout loans, now represent 72% of the allocations
for newly issued leveraged loans, according to a recent report by
analysts at Goldman Sachs Group Inc. Creation of new CLOs is also
trailing 2018 by 9.5%, the analysts wrote.
That becomes an issue because CLOs, which are typically issued
by the credit arms of private-equity firms and banks, have limits
on the number of low-rated loans they can own. After years of
steadily filling up their tanks with buyout loans, they are now
pushing back on the loose credit agreements and borrower friendly
terms they once accepted amid worries about rising loan
downgrades.
In some cases, that has left banks holding the bag and has
raised borrowing costs for private-equity firms, forcing them to
lower their return expectations for deals.
Banks in October struggled to sell about $2 billion in debt to
fund Apollo's purchase of online-photo service Shutterfly Inc. and
ended up agreeing to buy up to $280 million themselves, The Wall
Street Journal reported.
Write to Miriam Gottfried at Miriam.Gottfried@wsj.com
(END) Dow Jones Newswires
December 01, 2019 09:14 ET (14:14 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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