* Dealmakers say focus on value, not financial engineering
* Claim discipline in the wake of frothy debt markets
* Take advantage of refinancings to pay dividends
By Greg Roumeliotis
SAN FRANCISCO, Feb 15 As buyout kings once again
flirt with mega deals, they are pledging to avoid relying on
cheap debt, clever financial tricks and the other excesses of
the heady days that preceded the financial crisis.
The caution comes as private equity begins 2013 on a note of
both euphoria and solemnity. Silver Lake partnered with
technology billionaire Michael Dell earlier this month to take
his eponymous PC maker private for $24.4 billion in the largest
leveraged buyout since the financial crisis.
But in a grim reminder of what happens when bold bets do not
pan out, Energy Futures Holdings, formerly known as TXU, hired
restructuring advisers to sort out its swelling debt following
its $45 billion buyout - the largest ever - in 2007 by TPG
Capital LP and KKR & Co.
And in an example of an alternative to the private equity
model of mega deals, Warren Buffett's Berkshire Hathaway Inc
announced on Thursday it was stamping up a whopping
$12.12 billion in equity as part of its $23.2 billion takeover
of ketchup maker H.J. Heinz Co.
"Financial engineering at some point would reach its natural
limits," said Jim Davidson, co-founder of Silver Lake, at the
SuperInvestor conference this week in San Francisco. "If you
could always perfectly time the market, you will always
outperform. Historically that person doesn't exist."
The caution, despite a low interest rate environment where
debt is cheap and plentiful to do deals, means that executives
do not expect a substantial pick up in leveraged buyouts yet.
Moreover, after a stock market rally, private equity firms have
to work harder to find undervalued companies and come up with
plans to operate them better than the current management.
"You have to be disciplined," said Stephen Pagliuca,
managing director at Bain Capital LLC, a buyout firm with $67
billion in assets under management.
"If you buy a large company it has to be a special
opportunity and there are such opportunities out there," he said
at the conference. "There are conglomerates that have been badly
managed for years and you can unlock a lot of value by buying
Davidson, who founded Silver Lake in 1999 together with
Glenn Hutchins and David Roux, said the only sustainable path to
consistently deliver the returns private equity investors expect
was to invest in companies where they have good reason to
believe they can make a big difference.
"Strategies have to be real to outperform," Davidson said,
without specifically mentioning Dell.
Still, the proposed Dell Inc deal is atypical in
that it is far less leveraged than other LBOs of similar size
due to Michael Dell having agreed to roll over $3.7 billion
worth of equity and the company's cash reserves of more than $11
On a net basis, this brings the deal's leverage at just 2.5
times debt to earnings before interest, tax, depreciation and
amortization, a person familiar with the matter previously told
This compares with an average leverage multiple for private
equity deals in 2012 of 5.3 times, according to S&P Capital IQ
Leveraged Commentary & Data.
To be sure, private equity has not become impervious to
cheap money, nor is it a stranger to financial engineering.
Many buyout firms have been taking advantage of the buoyant
debt markets to borrow through their portfolio companies and
return money to their private equity fund investors through
"The financing markets are absolutely on fire. In the last
10 days we refinanced five of our companies. That's one every
other day. Some of them were companies we invested in six or
nine months ago," Philip Hammarskjold, chief executive of buyout
firm Hellman & Friedman LLC, told the same conference. "It
really is quite extraordinary."
Financing costs for deals are at historic lows as debt
investors chase better returns amid persistently low interest
rates, driving up demand for high-yield debt.
But discipline over equity investments has so far prevailed
in the frothy debt markets. LBOs in the United States totaled
$91.4 billion in 2012, up from $75.8 billion in 2011, according
to Thomson Reuters data. But the volumes are a far cry from over
$400 billion of deals seen, both in 2006 and 2007, before the
credit crisis took hold.
An example of such discipline came this week, with news that
private equity firm Carlyle Group LP recently approached
Nasdaq OMX Group Inc about taking the exchange operator
private. The talks fell apart because Carlyle did not want to
pay up for the company.
"There was a period of time where there was a lot of
leverage and staple financing, (investment) multiples were going
up and there was a lot of wind at the back of the economy. There
isn't that anymore so you have to be able to operate companies,"
CCMP Capital chairman Greg Brenneman told the conference.
As a result, private equity fund managers now have to
demonstrate Warren Buffett-like savvy in spotting bargains, come
up with novel ideas about transforming a company and then roll
up their sleeves to bring about change that will help the
company grow faster than the wider economy.
Adding to the challenge is the huge amount of money chasing
a limited number of deals. North America-focused private equity
buyout funds had $189.4 billion as of January 2013 in unspent
capital - so-called dry-powder - down just 12 percent from
December 2011, according to market research firm Preqin.
"It's frustrating when sometimes somebody can buy a business
at a price they shouldn't have paid, but can get out of it in
three years because the economy grew so rapidly," said Thompson
Dean, co-managing partner of Avista Capital Partners, a private
equity firm with over $4 billion of assets under management.
"We are not in that environment anymore. We place a heavy
emphasis on buying smart and operating well."