Buy-out firms put up 'for sale' signs as crisis hurts

Once thriving buy-out houses are set for a painful round of bartering among each other as the crisis hurts revenues of the highly indebted companies they own, shaking the trust of investors.

Struggling U.S. private equity firm American Capital Ltd is sounding out buyers for its entire $3.5 billion European Capital unit, Reuters reported on Thursday, and people in the industry say more is to come.

“There will be a few spectacular implosions and that will come not because of market conditions but because of total breakdown in relations between the parties,” said Ylan Steiner, a partner at law firm SJ Berwin.

American Capital’s move comes after it broke financial covenants and posted heavy losses, and resonates with that of European buyout shop Candover, which last week said it had entered into talks with potential buyers.

While such listed private equity firms have to air their linen in public, their privately-held rivals can conduct their discussions with investors behind closed doors. But their troubles are no less acute.

“There are a number of houses who are in the difficult situation where their investments and their equity value is entirely under water,” said Steiner.

Rigid structures
It may be 2010 before limited partners -- LPs, the industry term for investors -- force the bulk of these portfolios onto the market, said Andrew Sealey, managing partner at private equity advisory firm Campbell Lutyens.

“It takes a long time for LPs frustration to build up to take action,” said Sealey. “It’s going to take a while as performance figures come through over the course of the year.”

Many private equity fund structures were not set up for current tough market conditions, said Julian Mash, chief executive of Vision Capital, which specialises in buying portfolios of assets from others.

“Normally there is no ability to do anything radical with a fund without 100 percent LP consent -- and that means they are very rigid,” Mash said.

“If private equity funds were like corporates they could have rights issues, they could be taken over,” he said.

Firms such as Coller Capital, HarbourVest and Paul Capital that buy assets from other private equity firms are seen as natural buyers for portfolios.

Other private equity players may look to raise secondaries funds to pick up portfolios of assets on the cheap, such as Goldman Sachs, which recently closed a $5.5 billion secondaries fund.

The bank may look to back a team of three people leaving three private equity shops to raise a fund to buy distressed assets in Germany, said Charles Baillie, co-head of alternative investments at Goldman Sachs Asset Management.

Traditional buy-out houses will also be attracted to portfolios of assets, and many believe they will be able to do it out of their existing fund structure, said Scott Dunfrund, co-head of European corporate finance at Houlihan Lokey.

“People who ... weren’t looking at entire portfolios, are at least considering it now,” Dunfrund said.

But buying entire private equity funds is not without its pitfalls. If private equity firms buy a portfolio from a competitor on the cheap, they may well upset their investors if they happen to also be exposed to the rival.

“The biggest element of complexity ... are the conflicts of interest between all the stakeholders,” said Mash.

But with the spate of private equity firms slashing the value of their investments in recent weeks, and many of them breaching covenants, consolidation is inevitable.

And on the plus side, private equity firms may stand a chance to get companies they already know at a cheaper price.
“Now they have an opportunity to come in and buy the company at a discount to the fund value -- this can look fairly appealing,” said Dunfrund.