Private equity eyes Australia's debt-strapped firms

SYDNEY (Reuters) - Private equity firms are eyeing Australian companies hit by a steep rise in debt costs, but they will face challenges sealing deals as their own financing costs rise and as target firms hold out for pre-credit crisis prices.

Faced with high interest rates, an economy showing signs of slowing and sliding share prices, companies are turning to private equity for a capital injection.

"There are businesses starting to feel the strain of higher funding costs or (who) see strategic opportunities and need to clean their balance sheets," said Simon Pillar, a founder of the largest Australasian-headquartered buyout firm, Pacific Equity Partners (PEP), during an interview.

Earlier this week, Australia's central bank raised interest rates to a 12-year high of 7.25 percent and noted tentative signs that the red-hot economy might be cooling. Australia and New Zealand have the interest rates in the developed world.

In Australia, major commercial banks might even have to take the drastic step of rationing lending if their funding costs continue to be forced higher by the global credit crunch.

The benchmark for corporate lending in Australia, the Bank Bill Swap Reference Rate, is around 8 percent, well above the dollar or sterling London Interbank Offered Rate.

An early sign of the stress that some Australian companies are feeling was ABC Learning Centres' ABS.AX decision this week to sell 60 percent of its U.S. business to Morgan Stanley Private Equity, raising about A$750 million to repay part of its heavy debts.

ABC shares have been hammered after disappointing earnings and on concerns about funding its high debt levels.

"I think the next wave will come through as the Australian economy eventually slows and we will see some firms that have taken on too much debt," said David Jones, managing director at CHAMP Private Equity.

Private equity has plenty of capital to help these companies.

PEP for instance is putting the finishing touches to a new A$4 billion fund. In 2007, private equity firms raised a record $6.6 billion to invest in Australian companies, up from $4.5 billion in 2006, according to the Asian Venture Capital Journal.

BRIDGING THE GAP

Buyout firms typically use some of their own funds and a lot of cheap debt to buy companies. However, the cost of borrowing has gone up for them too and they cannot borrow as much because banks are concerned they may not be able to parcel out the debt to other investors due to a crisis of confidence in credit markets.

"In the near term it is going to be very difficult to get financing, but that will change," said Benjamin Jenkins, a senior managing director at buyout firm Blackstone Group

(BX.N).

A leveraged loan would have cost about 225-250 basis points above the base rate in Australia prior to the credit crisis that erupted mid-last year. Now it would cost around 300 basis points over the base rate, banking sources said.

It was not unusual for banks to lend 5-6 times the earnings of the target for a leveraged buyout. Now private equity funds would struggle to scrape together 3-4 times. Bankers suggest that A$1-1.5 billion is the maximum amount of debt a fund could raise to buy a very healthy company.

At the same time, private equity firms complain that owners of companies are still clinging to the hope they can sell out at pre-crisis prices.

"Clearly share markets have moved but that doesn't mean peoples' expectations of where they would sell a business have moved dramatically from where they were 3-4 months ago yet," said Justin Reizes, managing director at KKR Australia

KKR.UL.

However, private equity firms are looking at ways to bridge the divide. Many are prepared to use more of the equity in their funds to secure a deal, and then put more debt in later.

Last year private equity firms took whole companies private. Now they may scale back their ambitions and look to buy units of troubled companies. In February, buyout firm CVC Asia Pacific bought a 65 percent stake in tourism business Stella from Australian financial services firm MFS MFS.AX, allowing it to meet a debt repayment deadline.

"Private equity firms will become more creative in structuring deals while the credit crisis rumbles on," said Andrew Champion, head of a team in Australia and New Zealand at Citigroup (C.N) helping private equity firms do deals.

He suggested funds might also increasingly seek to partner corporates on deals, or acquire a controlling stake at the holding company level but keep a minority of the shares listed on the Australian stock exchange.

"There are other ways of doing things when financing gets difficult," said KKR's Reizes.

(Additional reporting by Umesh Desai, Editing by Ian Geoghegan)