Private equity eyes Australia's debt-strapped firms

By Alison Tudor, Asia Private Equity Correspondent

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).