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By Stephen Aldred and Denny Thomas
HONG KONG, June 19 A little over a month ago, a
Texas power utility at the centre of the biggest leveraged
buyout in history filed for bankruptcy, sunk by billions of
dollars of debt that it took on after being acquired by a trio
of top private equity names in 2007.
The failure of Energy Future Holdings, known as TXU Corp
when it was acquired at the height of the mega-buyout boom, is a
sobering reminder to investors in private equity funds that
heavily leveraged deals can - and do - go wrong.
But financial markets have short memories.
In Asia, private equity firms have amassed a record stash of
capital from investors seeking high returns from buyout deals
amid low yields around the globe. The firms have $138 billion in
unspent capital, or "dry powder" as it is known in the industry,
according to management consulting firm Bain & Co.
Unlike the West, sizeable buyout targets are still rare in
Asia. They represent under one-third of private equity M&A deals
for the past 14 years in the region, Thomson Reuters data shows.
So when assets do come up for sale, private equity firms try to
outbid one another with aggressive pricing. They are also
willing to take on expensive loans which are ultimately borne by
their target companies.
Earlier this year, Carlyle Group bought Tyco International's
South Korea home security business. In that deal, the
amount of debt borne by the target company would have raised
concerns with U.S. regulators had the transaction been done in
the United States.
"The strong inflow of funds into private equity coffers is
pressuring buyout firms to take extra risks," said Ian Ramsay,
Professor of Corporate Law at the University of Melbourne.
"We are not at a tipping point yet, but some deals show that
private equity investors do need to show some restraint," said
Ramsay, a former corporate attorney who worked closely with
banks on Australia deals.
At least $20 billion of the dry powder in Asia piled up in
the last 12 months as companies like KKR & Co, Affinity
Equity Partners and TPG Capital closed new funds to
invest in the region.
Private equity firms, in the process of buying out targets,
are also securing higher levels of loans, or leverage. The debts
are borne by the companies acquired with their businesses used
Typically, a private equity firm takes debt to finance about
two-thirds of a deal. Such highly leveraged deals ensure higher
returns, since private equity firms only need to tap a small
portion of their own capital for the acquisition.
Carlyle's acquisition of Tyco's South Korea home security
business ADT in March was significant both in terms of
valuations and the debt taken on to outbid Affinity Equity
Partners and KKR.
Washington D.C.-based Carlyle clinched the deal for $1.93
billion, or around 11 times ADT's earnings. In Europe and North
America, private equity has acquired similar assets for around
eight times earnings in recent years.
Carlyle also tapped 360 billion won ($354 million) of
mezzanine debt from UBS, a costly type of finance
rarely used in Asian buyouts, people familiar with the matter
said. The debt was well over six times earnings, according to
Basis Point, a Thomson Reuters publication, with the debt coming
largely from Korean banks.
Carlyle declined to comment.
HIGH DEBT MULTIPLES
Many Western banks have retreated from lending, and banks
that had booked losses through lending to private equity-backed
buyouts before the crisis are staying cautious.
As a result, private equity firms have started to tap U.S.
capital markets, a liquid depot where institutions such as hedge
funds offer large loans with relatively few covenants for the
KKR's recent $1.1 billion bid for Singapore container
company Goodpack Inc features debt of well over six
times EBITDA, or core earnings, much of it sourced from U.S.
capital markets. Two years ago, it was rare to see a buyout in
Asia backed with debt of more than 3.5 times earnings.
U.S. regulators have cautioned that debt levels of more than
six times earnings would be a concern.
Because of that warning, the same three banks backing the
Goodpack buyout - Credit Suisse, Goldman Sachs
and Morgan Stanley - recently refused to provide debt to
another KKR-owned company in the United States on concerns it
was too risky to pass muster with U.S. regulators. KKR declined
The risks are clear.
During the 2008 financial crisis, many private equity-owned
companies struggled to manage their debt. Some languished during
the downturn, and others went broke, causing financial losses to
banks who backed the buyouts, and to private equity owners.
In the Asia-Pacific region, Australian clothing and footwear
retailer Colorado Group, owned by Affinity, surrendered control
of its business to lenders owed $411 million in May 2011. The
company failed to cope with a weak sector and folded under the
weight of heavy debts.
CVC recorded Asia's biggest-ever private equity loss in 2012
when it lost Australian media company Nine Entertainment
to rival funds in a debt-for-equity swap. Nine had
struggled to cope with high debt levels as advertising revenue
declined during the financial crisis.
So far in Asia this year, private equity-backed M&A volume
is off to its fastest-ever start. Volume is at $28.1 billion
year-to-date, almost three times the level a year earlier, and
close to the $30.7 billion for the whole of 2006 during the
The costs can be high for all concerned, Ramsay warned, when
private equity deals fail and companies collapse.
(Reporting by Stephen Aldred and Denny Thomas; Editing by Ryan