Dealtalk: Private equity says won't be swept by Dell euphoria

Last Updated: Fri, Feb 15, 2013 07:27 hrs

By Greg Roumeliotis

SAN FRANCISCO (Reuters) - 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 these companies."

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 billion.

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 Reuters.

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 dividends.

"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."

(Reporting by Greg Roumeliotis in San Francisco; Editing by Paritosh Bansal)

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