KKR’s Kravis Says Tighter Credit Markets Are Making Buyouts More Expensive
Henry Kravis, co-founder of KKR & Co., said private-equity deals are becoming more expensive as the reluctance of banks and investors to lend drives up borrowing costs.
“As the debt markets tighten and the cost of capital goes up, something has got to give,” Kravis said yesterday at the Bloomberg Dealmakers Summit in New York. “You just have to pay more.”
Kravis, 67, said the cost of capital for a leveraged buyout has risen more than 2 percentage points since the firm agreed to buy Pfizer Inc.’s Capsugel unit in April, forcing buyers to put up more cash for deals and borrow less. Uncertainty in the equity markets also is making it more difficult to reap profits through initial public offerings or sales of companies owned by private-equity funds, he said.
Private-equity transactions rose 51 percent to $287 billion this year over the same period a year earlier, Bloomberg data show. Economic uncertainty and volatile equity and debt markets have stunted recent dealmaking. Announced transactions in September dropped to $8.2 billion from $29 billion in August.
“Right now it’s harder to exit situations, but the reality is what goes down comes up,” Kravis said.
Junk bonds, a staple of LBO financing, have lost about 2.1 percent this month, following a decline of 4 percent in August, Bank of America Merrill Lynch data show. That’s the worst back- to-back performance since the failure of Lehman Brothers Holdings Inc. prompted a seizure in credit markets, leading to a decline of 23 percent in October and November 2008.
The total cost of capital for the Capsugel purchase was 6.88 percent, Kravis said. The same deal today would cost “just under” 9 percent, he said.
European economies are “very troubling” and face larger problems than the U.S. after the 2008 bankruptcy of Lehman Brothers Holdings Inc., said Christopher Flowers, founder of private-equity firm JC Flowers & Co.
Flowers, speaking at the conference, said he is keeping “plenty of cash and capital” in the event of a deeper crisis.
“In Europe, you have sovereign states that don’t control their own currency,” said Flowers, 53, who is chairman and chief executive officer of the New York-based firm. “It’s going to be an interesting situation.”
Flowers, who has been investing in the U.K. and Europe in the past year, said interbank lending in the region is dead. While Europe is the “most dangerous it’s been,” the European Union will probably succeed at holding the regional economies together, he said.
Private-equity firms may lower return targets as banks shun financing leveraged buyouts at past levels, said Guy Hands, chairman and chief investment officer of Terra Firma Capital Partners Ltd.
With less debt, buyout firms may target returns of “20- plus percent” from 25 percent to 30 percent previously, Hands said at the conference. He sees a “rocky” 18 months ahead, with “attractive” returns beyond 2013.
“The bankers are not coming out, and they will not come out until they have the liquidity,” said Hands, 52. “There’s less incentive for a bank to provide financing now. The reality is, pre-January 2008, it was very profitable to do private- equity financing” because of the multiple opportunities to generate fees, he said.
Buyout firms typically use loans secured on the targets they acquire to finance more than half of the purchase price and cash from their own funds for the rest. The firms seek to improve performance at the companies they acquire or expand them before selling them within about five years.
KKR, which Kravis created in 1976 with George Roberts and Jerome Kohlberg, is expanding into hedge funds, real estate and underwriting to reduce reliance on buyouts after the firm gained a listing on the New York Stock Exchange last year. KKR this year hired a group of former Goldman Sachs Group Inc. (GS) traders led by Bob Howard to start KKR’s first hedge fund.
KKR, which last year listed shares in New York after combining with its publicly traded European fund, has lost 20 percent this year. The stock rose 14 cents, or 1.3 percent, to $10.90 at 4:15 p.m. yesterday in New York Stock Exchange composite trading.
An 11 percent decline in the Standard & Poor’s 500 Index this quarter has made it harder for firms to exit investments and return money to investors, Kravis said. KKR earlier this year sold HCA Holdings Inc. in an initial public offering. It has yet to complete a planned IPO for Toys R Us Inc.
The firm, which has participated in some of the largest deals in private-equity history, is gathering as much as $10 billion for North American private-equity deals. KKR has already raised money to invest in natural resources investments and this month pooled $1 billion for mezzanine loans used to finance takeovers.
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