* Private equity funds seek to diversify to achieve return
* In some strategies, funds may have influence but not
* Companies see strategic, financial benefits in
By Greg Roumeliotis
NEW YORK, Dec 31 Private equity firms are
increasingly seeking to partner with U.S. companies rather than
buying them outright, as they struggle to find ways to put their
huge piles of money to work at a time when frothy markets have
made takeovers expensive.
Major U.S. buyout shops, such as Blackstone Group LP
and Carlyle Group LP, are looking at deals such as
minority investments in companies or partnerships with companies
looking to make an acquisition -- types of transactions that
they largely shunned before the financial crisis of 2008.
Carlyle, for example, did no such deals in Carlyle Partners
IV, a $7.8 billion U.S. buyout fund raised in 2005. But it ended
up investing about 15 percent of its $13.7 billion Carlyle
Partners V fund, raised in 2007, in such non-conventional deals.
It sees potentially even more such deals for the U.S. fund
it raised this year, the $13 billion Carlyle Partners VI fund.
In September, for example, it agreed to invest $500 million for
a minority stake in Beats Electronics LLC, the headphones
company co-founded by rapper Dr. Dre.
"You clearly need to do more of those deals to get your
targeted rate of return," said Peter Clare, co-head of Carlyle's
U.S. buyout group, who noted that the share of non-conventional
deals could top 15 percent in its latest fund.
Private equity executives argue non-conventional deals can
be more lucrative when full-blown buyouts are expensive.
Competition for them is less, as the transactions are
custom-made and often do not involve auctions.
"Once we have an investment in a company we will do
everything we can to help them achieve their goals, whether it
is investing more money or not," Clare said.
While such non-conventional investments account for a small
minority of private equity deals, they underscore the industry's
desire to avoid the debt-fueled excesses of the 2005-2008 buyout
boom in today's environment, in which cheap financing and high
equity prices favor selling companies rather than buying.
Private equity firms took advantage of red-hot capital
markets to cash out on investments throughout the year, an
approach epitomized by Apollo Global Management LLC
co-founder and Chief Executive Leon Black in April with the
phrase: "We are selling everything that is not nailed down."
Deploying capital has been more challenging. Although
private equity-backed deal volumes are up 31 percent
year-on-year in the United States in 2013 thanks to megadeals
such as Dell inc and H.J. Heinz Co, the number of deals went
down from 1,917 in 2012 to 1,715 in 2013, according to Thomson
At the heart of private equity's predicament is a problem of
plenty. The industry ended the year with $585 billion of "dry
powder" to spend in North America, the highest since 2009,
according to market research firm Preqin, thanks to yield-hungry
investors, such as pension funds and insurance firms, piling in
amid record-low interest rates.
At the same time, these firms have struggled to find enough
buyout opportunities to invest in to make the 20 percent annual
return they like to promise to the investors in their funds, who
are known as limited partners (LPs).
Fierce competition for attractive buyouts and a U.S. stock
market rally - the S&P 500 has gained 29 percent this year -
means the average price firms pay for leveraged buyouts has
increased to levels not seen since 2008, the end of the last
buyout boom that preceded the financial crisis.
The median earnings before interest, tax, depreciation and
amortization (EBITDA) multiple in U.S. leveraged buyouts jumped
to 9.8 times in 2013 from 8.3 times in 2012, according to
Preqin. A recent research paper by a group of academics at the
London School of Economics, University of Oxford, University of
Chicago Booth School of Business and Ohio State University,
shows funds that buy companies at higher EBITDA multiples tend
to report worse returns.
Blackstone Chief Executive Stephen Schwarzman told a Goldman
Sachs industry conference earlier this month that when a stock
market rallies as much as this one has "and valuations all go
up, what we try and do is not load the boat at that period of
time because that's irrational".
Just this month, Blackstone agreed to invest $200 million
for a minority stake in shoe company Crocs ; Silver Lake
Partners agreed to offer $1 billion in financing for Avago
Technologies Ltd's $6.6 billion acquisition of
semiconductor maker LSI Corp ; and Deere & Co sold
the majority of its equity in its landscaping business to
Clayton, Dubilier & Rice LLC for $300 million, retaining a 40
In the case of Crocs and Avago, the private equity firms
will not have majority control, but they have strong influence
over the outcome. Silver Lake already has a seat on Avago's
board of directors as a result of its ownership of the company
between 2005 and 2012, while the Crocs deal gave Blackstone two
seats on the company's board.
Both companies said they would also benefit from the
expertise and advice the private equity firms will offer. They
also had financial incentives.
Avago's $4.6 billion loan package backing its acquisition of
LSI had a blended interest rate of about 3.5 percent as of the
day it was announced, while the $1 billion convertible bonds
issued to Silver Lake have a fixed 2 percent coupon.
Crocs said it would use proceeds from its $200 million sale
of preferred stock to Blackstone, as well as cash on its balance
sheet, to fund a $350 million common stock buyback program.
Following the announcements of these two deals, both Avago
and Crocs rallied above the common share price at which Silver
Lake can convert its bonds and Blackstone can convert its
INVESTORS FEEL CONFLICTED
The jury is still out on whether such investments will boost
returns for fund investors. In the past, such deals have also
ended up costing some firms dearly.
For example, Hicks, Muse, Tate, & Furst Inc, one of the
biggest buyout firms of the 1990s, spent too much on stakes in
public telecommunications companies that did not pay off,
eventually leading to the closure of the firm after many
investors were disappointed with its results.
Private equity executives tell their limited partners that
these deals offer them exposure to companies that they could not
get otherwise and facilitate transactions that would not have
been feasible without the use of their capital.
For now, fund investors are playing along. Some believe they
have little choice.
"LPs are conflicted because they see private equity doing
things outside its sweet spot and are not sure how this will
turn out," said Kelly DePonte, managing director at private
equity advisory firm Probitas Partners LLC. "But at the same
time, they want to be paying management fees on invested capital
rather than dry powder."