Private equity dives into alternatives, LBOs dead

Date: Wednesday, February 4, 2009
Author: Megan Davies and Philipp Halstrick, Reuters.com

Private equity firms are being forced to dive into alternative investments or sit it out on the sidelines, as the credit crisis kills their ability to strike large leveraged buyouts.

The mood was gloomy at the industry's main conference, SuperReturn, on Tuesday, as executives stressed their focus on keeping portfolio companies above water, and facing extra time waiting it out to offload them.

"You have to accept the fact that transactions will be smaller and have far less leverage -- that's a fact," said Henry Kravis, co-founder of New York-based private equity giant Kohlberg Kravis Roberts & Co.

"That means all of us have to adapt. We have to change the way we'll do business. If we don't, we'll be left out."

Kravis said the firm was seeking alternative investment opportunities instead of buyouts, as it waits out the credit crisis, including distressed debt, mezzanine financing and infrastructure.

That was echoed by Leon Black, founder of rival New York-private equity firm Apollo Management LP

"Traditional buyouts are essentially dead for the time being due to the lack of financing," said Black. "The big public-to-privates are gone in the way of the dodo."

Black, who finished raising a $14.8 billion fund in December, expects to be buying debt for the next two years instead, with the focus on credit-oriented investments, particularly in large senior loans and distressed assets.

"When financing comes back we will be a classic buyout house again but not till then," Black said.

He said that for the last 18 months Apollo hadn't struck any traditional private equity deals.

Scott Sperling, co-president of Boston-based private equity giant Thomas H. Lee Partners said valuations of companies were still too high to dive in.

"I think the issue in traditional buyouts has to do with the valuation of companies and the nature of debt available," he said during a panel discussion at the conference.

SEA CHANGE

Delegate numbers were down 200 from last year's conference with the event drawing 1,200, an organizer said. The shutdown of London's airports meant more disruption as attendees coming from snowed-up England had problems traveling.

The economic and financial crisis is leading to a fundamental change in the business model of the buyout industry and the topics of conversation were a sea change from two years ago, when remarks were about achieving bumper returns and striking $50 billion deals.

Now, problems in portfolios, the erosion of leverage and accounting issues which are causing writedowns in the funds dominated the discussions.

Kravis said looking after the portfolio was his most important focus in 2009.

"It's portfolio, portfolio, portfolio, it's our obligation," he said. "We will focus laser-like on the portfolio. Nothing is more important than managing that portfolio. Our investors demand it."

The economic forecasts were also grim.

Apollo's Black said the economic situation was "broader and deeper than everything we have faced in the past."

Kravis predicted a long and protracted slowdown ahead and said the financial system "must begin to work properly and the credit markets must open up."

However, he said "one ray of sunshine" was the substantial level of new investment grade debt issued in the United States over the last few weeks without a government guarantee -- the first time in many months.

He also pointed to high yield debt issued without a government guarantee and commercial paper rolling over without a government guarantee.

"That was very important," Kravis said. "It is another indication that maybe things are starting to get better."

Scheduled speakers on Wednesday include Carlyle's David Rubenstein. A Carlyle investment, car roofing specialist Edscha, filed for insolvency for its European sites on Monday.