Debt Loads Expose Private-Equity Game: David Pauly

(Corrects spelling of company name in seventh paragraph.)

Private equity is one of Wall Street’s great euphemisms.

So-called private equity firms put up little equity when they make acquisitions. They are all about debt, gobs of it. We should call them by their proper name: leveraged-buyout firms.

LBO firms such as Blackstone Group LP, the biggest of the bunch, and KKR & Co. have even less business calling themselves private investors since they have become public companies.

The recession and its aftermath have shown once again the folly of loading up with debt at the expense of equity.

Big names in LBO portfolios like hotel chain Hilton Worldwide, casino-operator Harrah’s Entertainment Inc. and the Texas power company formerly called TXU Corp. have negotiated better terms from their lenders, or need to do so.

Not surprisingly, LBO firms, once the darlings of pension funds and college endowment funds, are having trouble raising new funds to do more takeovers.

They took in only $13 billion of new money for buyouts in the first quarter, compared with a peak of $68 billion in the first quarter of 2008, according to Preqin Ltd., a London research firm.

Leveraged buyouts were conceived to take public companies private at a premium to market value with mostly borrowed money, then milk the targeted companies for management and advisory fees and finally take them public again in about five years -- and score a big capital gain.

No Relief

In their current sad state, LBO firms can’t increase their fees much by making more acquisitions and the poor results of companies they own has diminished the potential of reselling them at a profit. Blackstone, which also has real estate funds and investments in hedge funds, reported a net gain from investments of $176.7 million in 2009, a decline of 97 percent from $5.42 billion two years earlier.

Blackstone, founded by former U.S. Commerce Secretary Peter Peterson and Chief Executive Officer Stephen Schwarzman, sold stock to the public in 2007 at $31. Its average share price since then has been about half that amount.

Last week, Blackstone managed to reduce the debt load at its Hilton chain by $3.9 billion, to about $16 billion, and extend its maturity by two years to 2015. Hilton bought back $1.8 billion of debt and converted another $2.1 billion into preferred equity.

Gone Begging

Twice since it was bought in 2008 by TPG Inc. and Apollo Management LP, Harrah’s Entertainment has managed to talk lenders into cutting the amount it owes and giving it more time to pay.

Apollo recently reduced the value of its Harrah’s stake by $152 million, to $884 million, according to a letter sent to Apollo’s clients. At the end of 2009, Harrah’s had $18.9 billion in long-term debt, against only $1.78 billion in equity. The curse of leverage will continue.

TXU, now called Energy Future Holdings Corp., was bought by TPG and KKR in 2007 in the biggest LBO ever, about $43 billion. It now may be the biggest LBO headache ever. Bonds sold by the utility due in five to seven years have been trading at about 72 cents to 78 cents on the dollar.

All’s not lost for LBO firms. KKR was able to sell a small stake in Dollar General Corp., a discount retail chain, last November at $21 a share. The stock traded as high as $27.01 last week.

Carlyle Group, the second-largest LBO firm, has raised $1.1 billion to buy distressed financial companies. The money will be managed by Olivier Sarkozy, half-brother of French President Nicolas Sarkozy.

These investment outfits no doubt will regain their popularity one day. But never forget that their trade is risky leveraged buyouts. Leverage as in debt, debt, debt.

(David Pauly is a columnist for Bloomberg News. Opinions expressed are his.)

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To contact the writer of this column: David Pauly in Fort Myers, Florida dpauly@bloomberg.net

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