NEW YORK, Oct 21 (IFR) - When private equity firm KKR & Co set its sights on a small Midwestern retailer in late 2015, it turned to some of the largest banks on Wall Street to obtain debt financing for the acquisition. It found no takers.
After a handshake deal with the company over the Thanksgiving holiday weekend, KKR was unable to get the money it needed from the two dozen banks it contacted, as a sharp market sell-off sparked a broad pull-back from lending.
Rather than walk away from the deal, a team of capital markets professionals on the 41st floor of KKR’s headquarters in Midtown Manhattan took matters into their own hands.
“We started to feel the banks wobble,” Adam Smith, KKR’s head of capital markets, told IFR. “The debt markets were shut.”
Bypassing the banks - and their underwriting fees - Smith’s team raised the entire US$815m of debt needed to close the purchase directly from investors, allowing KKR’s acquisition of Mills Fleet Farm, a retailer that sells items from hunting rifles to farm supplies, to be announced a few weeks later.
The Mills deal marked the culmination of a decade-long effort by KKR to build a fully fledged capital markets business.
It originally set up the group in late 2006, during a leveraged buyout boom that pushed deal sizes to new highs - and before the subsequent bust just a year or so later.
As equity cheques got bigger prior to the crash, sponsors were forced to partner up in so-called club deals to get enough downpayment together. But KKR, sceptical about the strategy of sharing lucrative business tips with rivals, was thinking about how to go it alone.
“You would have multiple sponsors with their hands on the steering wheel and that is just a very tough way to drive,” said Smith, who joined the firm in 2007 from law firm Simpson Thacher and helped jump-start the capital markets initiative.
“We decided to go out and raise our own money.”
When the firm bought discount retailer Dollar General for about US$7.3bn later in 2007, it was in a position to ditch the club-style approach.
KKR stumped up half the US$3bn equity check itself, and turned to a number of investors directly for the rest. The debt commitment, meanwhile, was provided by Goldman Sachs and Lehman Brothers.
Then the financial crisis hit.
As dealmaking dried up, KKR’s capital markets team turned its attention to managing the more than US$200bn debt load its portfolio companies had accumulated during the boom times.
“We had debt that needed to be extended, repriced or refinanced,” Smith told IFR. “We wanted to have people internally that were able to speak to the market ... and address any capital structure issues ... directly with the buyers of debt.”
That debt pile included two of the largest buyouts in history: KKR’s US$29bn purchase of credit card payment processor First Data and the US$45bn takeover of Texas power utility TXU - for which KKR partnered with rival TPG.
Both would give KKR’s capital markets team plenty to work on in the following years.
TXU - renamed Energy Future Holdings - ultimately filed for bankruptcy in 2014, while First Data tackled its debt overhang through a recapitalisation, an IPO and a series of refinancings.
Ten years from the crash, KKR is winning business from some of its private equity rivals. In fact, the 45-strong global capital markets team, with offices in New York, London, Hong Kong and Mumbai, now focuses 30% of its business on providing financing to companies outside KKR’s portfolio.
Earlier this year, for example, KKR was hired to lead a US$300m tap of a syndicated term loan for WME/IMG - a talent agency owned by Silver Lake, a tech-focused private equity firm.
KKR also partnered with Jefferies last year to underwrite and distribute a US$1.56bn bond and loan financing for Veritas Capital’s buyout of aircraft maintenance firm StandardAero.
Indeed, the capital markets group has become a decent revenue earner for the private equity giant, contributing more than US$1bn to the firm’s total revenues since 2010, or around 6%.
That includes fees that KKR picks up by being a bookrunner in leveraged loan and junk bond markets - often on financings for its own private equity investments - as well as from equity capital raisings.
Having a direct relationship with the buyside has also allowed KKR to pick up business in areas where banks have pulled back, such as risky financings that fall outside the leveraged lending guidelines set by US bank regulators.
“Having someone who is in the market every day and knows the players is hugely beneficial in the execution, particularly in this new world of banks no longer being open to underwrite the entire capital structure,” a lawyer who works with several private equity sponsors told IFR.
Other private equity firms have also taken steps in recent years to improve their capital markets expertise to structure financings and manage relationships with underwriters - TPG, Apollo and Blackstone among them.
But bankers say no firm has matched the breadth and size of KKR’s capital markets group.
The firm’s success has not gone unnoticed by banks, some of whom worry how far this trend will go.
“What we fret about is whether sponsors are competing with the banks,” said one leveraged finance banker who has worked with KKR.
“They have a unique capability and a great relationship with investors ... but I don’t believe they want to be syndicate desks.”
Carlyle Group, another industry heavyweight, takes a very different approach. It has stuck to a model in which each industry team is responsible for all stages of their acquisitions, including financing.
And some investors say they like the role banks play as an intermediary between the buyside and private equity firms.
“You expect at least a certain degree of due diligence by the bankers,” said one portfolio manager who buys leveraged loans and high-yield bonds. “I would be somewhat suspect of buying a KKR deal that KKR is marketing itself.”
Mark Durbiano, a senior portfolio manager at Federated, said his firm is yet to buy debt directly from private equity sponsors.
“You have to think about counterparty risk and who you are doing business with,” he told IFR. “If a substantial part of the business were to move in that direction, we would consider it.” (Reporting by Davide Scigliuzzo; Editing by Steve Slater, Natalie Harrison and Matthew Davies)