Europe Stymies Private Equity as Corporate Buyouts Stall
The world’s biggest buyout firms should be feasting in Europe right now. Instead, they’re settling for scraps.
Private-equity firms have raised $122.4 billion for corporate takeovers in Europe, more than they had in 2006 amid the record leveraged-buyout boom, according to London-based researcher Preqin Ltd. At the same time, the value of announced private-equity deals in Europe fell 51 percent to $57.2 billion this year through yesterday from the same period in 2011.
With the region in its third year of crisis, firms have been stymied by the lack of bank loans needed to make buyouts profitable for their investors and an unwillingness on the part of sellers to accept lower-than-expected prices. The slump in deals is putting to the test a thesis that firms such as Carlyle Group LP (CG), Blackstone Group LP (BX) and KKR & Co. (KKR) have long argued -- that they’re at their best when public markets panic, because their capital is locked up for about a decade, allowing them to invest with a long-term perspective.
“A piece of the equation, the leverage, is missing,” said Antoine Drean, chairman of Triago Europe SA, which advises private-equity funds. “A lot of this dry powder is going to vanish,” he said, referring to uninvested capital.
Firms that fail to put the money to work within a given time, usually five years, may be forced to release clients from their commitments, resulting in lost fees and making it harder to raise as much money for new funds.
“Everything in Spain is for sale, and yet to buy anything is very difficult,” said Tom Barrack, the chairman of Los Angeles-based Colony Capital LLC and longtime private-equity and real estate investor. “Italy is the same thing. The banking and corporate structure is at a standstill.”
Buyout firms are nonetheless seeking an additional $23.1 billion for investments in Europe, though for smaller funds than during the boom, according to data compiled by Bloomberg. By comparison, the firms are seeking $16.8 billion for buyout funds in North America.
Blackstone gathered about $16 billion for its sixth flagship global fund, after getting a record $21.7 billion for its fifth. Bain Capital Partners LLC is marketing a $6 billion fund, versus about $10 billion for its last pool.
Private-equity firms’ annual management fees, which usually range from 1 percent to 2 percent, are calculated as a percentage of the total commitment; performance fees, or carried interest, are usually 20 percent of profits from successful deals. Smaller funds and deals stand to crimp future earnings.
Blackstone and others have responded by expanding other divisions such as fixed-income investing, making private equity a smaller portion of the business. At Blackstone, private equity accounted for about 15 percent of the firm’s profit in 2011, compared with almost 30 percent in 2007, according to data compiled by Bloomberg.
Buyout executives have told investors they’re skilled at profiting from economic and market turbulence. They made that case after Lehman Brothers Holdings Inc. collapsed in 2008 and they’re repeating it as leaders of the euro region strive to prevent Italy from requiring a bailout like those in Spain, Ireland, Portugal and Greece.
“This is a fantastic time to make investments,” William Conway, Carlyle’s co-chief executive officer, said during a May conference call to discuss the Washington-based firm’s earnings outlook. “It is precisely in times like this, when economic data and markets are sending confusing signals, that the best investments can be made.”
The firm, which began operating in Europe in 1997, is set to raise its fourth European fund this year. Carlyle declined to comment on the new fund.
Carlyle Europe Partners III, which raised 5.4 billion euros in 2006, had an annual return of 5 percent through the first quarter of 2012, the firm said in May. Carlyle has bought three companies in Europe so far this year.
Marco De Benedetti, co-head of Carlyle’s European buyout group, said prices have come down in the region as small and medium-size corporations struggle to get bank loans. Those companies are more willing to listen to talk of funding from private-equity firms, he said.
“Banks are much more cautious,” De Benedetti said, noting that several have cut staff assigned to financing buyouts. “There is a credit crunch in Europe for medium and small companies, which creates opportunities for us.”
That reluctance to lend, while creating opportunities, is also hurting LBOs.
“It’s difficult to put deals together from a financing perspective,” said Tripp Smith, a Blackstone senior managing director and co-founder of the New York-based firm’s GSO Capital Partners business. He said he’s seen heavier demand for GSO’s mezzanine loans, a type of loan that’s typically more expensive for the borrower than bank debt.
The average interest for leveraged loans used to fund private-equity firms’ buyouts in Europe has risen to 468 basis points more than benchmark lending rates this year, as of July 17, from 417 basis points a year earlier, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.
Uncertainty over the duration and severity of Europe’s crisis has also hampered deals between buyout firms. Permira Advisers LLP, a London-based private-equity firm, this month called off the sale of U.K.-based Iglo Foods Group Ltd. after receiving bids it deemed too low, and said it has also stopped exploring ways to pay itself a dividend from its stake in the fish-stick maker.
Permira had considered refinancing Iglo’s debt instead of selling its stake after Blackstone and BC Partners Ltd. submitted an offer last month that fell short of Permira’s target, people with knowledge of the talks said at the time.
Vulture funds, designed to snap up unwanted loans and other assets from banks, have similarly struggled to find deals as the lenders wait for prices to increase.
The debt-financing bottleneck echoes the bind private- equity firms found themselves in during the 2008-2009 global financial crisis, when managers sought ways to invest money outside traditional deal-making in the U.S.
Last month, KKR provided financing for another firm’s takeover, EQT Partners AB’s 1.8 billion-euro ($2.2 billion) purchase of German bandage supplier BSN Medical. KKR’s contribution came from a $1 billion mezzanine fund raised last year that has backed leveraged buyouts by firms including Permira and Boston-based Bain.
The mezzanine fund, managed by Frederick Goltz, is part of KKR Asset Management, the San Francisco-based unit run by William Sonneborn. That unit, known as KAM, also comprises the hedge-fund business of former Goldman Sachs Group Inc. (GS) managing director Bob Howard, as well as a group dedicated to special situations including short-term financing for struggling companies. KKR is counting on KAM to counter a drop in profits from leveraged buyouts that extends beyond Europe.
Blackstone, KKR and Carlyle have expanded their non-buyout units in the past five years. The firms have bulked up teams to buy distressed debt through the public markets and negotiate private loans for companies in trouble.
“There’s a huge dislocation because there’s no money, and in dislocation, there’s the opportunity for tremendous deals,” said Blackstone’s Smith. “But it’s expensive, and it’s going to be hard.”
Smith relocated to London from New York earlier this year and oversees a 40-person Blackstone and GSO effort there and in Dublin. At KKR, Nathaniel Zilkha moved to the London office from San Francisco last year as co-head of the special-situations group. Eight of the 17 dedicated special-situations investors are in London now, versus one at the end of 2010, he said. Many of the deals are far from plain LBOs.
“We’ve been really busy putting capital in the ground,” Zilkha said in an interview. KKR has about $2 billion to spend globally on special situations such as the February deal to finance a U.K. refinery managed by PetroPlus Holdings AG. “We think of ourselves as white-knight distressed investors. We’re solving things in a conference room and not a courtroom.”
Businesses outside of corporate buyouts can be less profitable. At Blackstone, the credit business had a profit margin of about 36 percent in 2011, less than the 42 percent delivered by the private-equity group, according to data compiled by Bloomberg.
The largest buyout firms have said they’re shoring up current holdings to withstand a potential meltdown spurred by Greece, Spain and Portugal. Top executives at KKR and the Carlyle told their investors last month they’ve spent months pressing the companies they control to refinance and cut costs ahead of what may be a prolonged downturn in Europe.
“We’ve been trying to get as lean as we can,” Scott Nuttall, KKR’s head of global capital and asset management, said at a conference in New York on June 6. A week later, Glenn Youngkin, Carlyle’s chief operating officer, described a “Herculean” effort to cut costs and refinance his firm’s 33 European holdings.
Still, a few transactions are getting done. Advent International Corp., based in Boston, has struck at least three deals in Europe in the past 12 months, including one in Spain and another France. The biggest was Advent’s takeover of Francois-Charles Oberthur Fiduciaire SA’s smart card unit for 1.15 billion euros announced in August of last year. The company’s security and identification technology is used in the mobile telecommunications, payment and transport industries.
Advent also secured 70 percent of the 7 billion euros it’s targeting for a new fund, a person familiar with the firm said in June. The firm declined to comment on fundraising.
“One school of thought is to stay out of Europe because deal volume is down and there’s too much uncertainty,” Advent’s Fred Wakeman said in an interview last month. “That’s not our view.”
KKR said on July 6 it offered to buy German coffee-machine and cutlery maker WMF Wuerttembergische Metallwarenfabrik AG for 586.2 million euros and upped its offer slightly a week later on the instruction of a financial regulator. Other private-equity firms had been interested in WMF, which is being sold by Zurich- based CapVis Equity Partners AG, people familiar with the sale said in April.
TPG Capital, like some of its competitors, has been exploring Europe in part through its special situations and real estate groups, headed by Alan Waxman and Kelvin Davis, respectively. TPG and Patron Capital Partners together agreed to buy a portfolio of Dutch non-performing commercial mortgage- backed securities in April for 358.8 million euros. The handful of transactions getting done may portend more as Europe heals, albeit slowly.
“At the moment there is more capital waiting than there are deals,” James Coulter, co-founder of TPG, said in an interview. “Only small pieces of the ultimate opportunities are currently showing themselves and they are doing so quietly. It will take patience and time.”
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