DEALTALK-Private equity sees new fund sources amid slowdown

LONDON (Reuters) - Facing an extended vacuum in funding for leveraged deals, private equity firms are looking as far afield as hedge funds and sovereign wealth funds to fill the gap.

At the same time, they're making their business models less reliant on the buyout deals that sustained them through boom times.

Banks are clogged up with $200 billion (101 million pounds) or so in unsold debt that they need to unload before financing other deals, and it's anyone's guess how long that will take.

For an industry built on aggression, sitting back until banks lend again isn't an option. Finding other sources of funding is.

Private equity bosses in the U.S. and U.K. said this week at a conference in Munich that they'd tap sources such as sovereign wealth funds, hedge funds and pension funds to finance deals.

As U.S. buyout firm Carlyle Group's founder and managing director David Rubenstein said: "When there's a vacuum, people go in to fill it."

Already, buyout firms are going directly to hedge funds for financing. Among the lenders for Hellman & Friedman's $1.8 billion purchase of manufacturer Goodman Global Inc were GSO Capital Partners and Farallon Capital Management.

UK-based Terra Firma Capital Partners' Chief Executive Officer Guy Hands said at the conference that if banks refused or were unable to underwrite mega-deals, private equity would go straight to the pension funds, sovereign wealth finds and even the global money markets.

Charles Sherwood, a partner at European private equity firm Permira, said there is a clear opportunity for sovereign wealth funds to step in and provide leverage.

Supporting that prediction are estimates that sovereign wealth funds' assets are set to boom. Morgan Stanley estimates they'll grow assets from $2.8 trillion in 2007 to $12 trillion in 2015.

Another source private equity is tapping is smaller banks not so hard-hit by the lending crisis. Financing in the recently announced buyout of Turkish supermarket MigrosMIGRS.IS by European buyout firm BC Partners was provided entirely by local banks.

DIVERSITY COUNTS

With mega-buyouts off the table and a U.S. recession likely, having other streams of business to rely upon is also key.

"The drop in leveraged deals doesn't mean we're not busy -- our business is not just buyouts; we have a huge real estate portfolio and a hedge fund business and we are active in emerging markets," Blackstone Group (BX.N) CEO Stephen Schwarzman told Reuters.

Blackstone, which is behind some of the biggest buyouts in history, has a huge real estate business and other streams of revenue, such as M&A advisory.

It recently announced plans to buy hedge fund GSO Capital Partners LP, which specializes in leveraged finance. Schwarzman said at the time of the acquisition that dislocation in the credit markets made it "an ideal time" to expand this business.

With the economy weakening, firms also see opportunities investing in situations as companies get into trouble, such as buying discounted debt or distressed assets. That could make the funds invested in the next few years reap a better return than those spent during the departed economic boom.

Ripplewood Holdings LLC, which specializes in fixing struggling companies, sees opportunities to be found amid a tough U.S. economy that could fall into recession.

"The golden age is when capital is scarce, courage is scarce and you can use your capital, not only to create extraordinary returns, but to play a really important role in this transition period in the economy," Collins said this week. He estimated that such an environment would persist over the next two or three years.

While fund-raising for buyout funds may have become harder, pension funds have in the main kept or raised their allocation to private equity.

Recent data from London-based research firm Private Equity Intelligence Ltd (Preqin) said all the major investment groups in private equity have average target allocations to private equity that are several percentage points higher than their current allocations -- indicating that several hundred billion dollars of additional capital is set to flow into private equity in the next few years.

And at some point, the markets will come back.

"I don't think we have seen the high-water mark. We have seen these downturns before and each time ... have emerged stronger and stronger," Carlyle's Rubenstein said.