Private Equity Braces For Downturn?

Senior participants are cautioned that today’s market could be as good as it gets, despite a powerful global economic backdrop and buoyant disposition in the private collateral and leveraged loan markets. Comparisons to 2007’s pre-crisis conditions are becoming more prevalent and industry statistics are debating whether today’s sturdy conditions constitute a bubble, as purchase prices rise, jumbo buyouts proliferate and deal terms become more aggressive. “I believe we’re now in bubble territory,” said Frode Strand-Nielsen, founder of Nordic private equity firm FSN Capital. Blackstone is buying a 55% stake in Thomson Reuters’ Financial and Risk unit, which include LPC.

Strong debt markets are currently seeing good trader demand, but private collateral firms are concentrating on companies they can take through a tough economy, Gregor Bohm, co-head of Carlyle’s European buyout business, said at Berlin’s SuperReturn meeting. “You must sell all the ongoing companies that you don’t want to carry through a recession,” he said. Another five years is actually a difficult environment for private equity and leveraged credits, Strand-Nielsen said, particularly as buyouts that have been financed with cheap debt shall get more expensive if interest rates rise.

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“There’s a great deal of financial engineering, which indicates we’re going into a concerning environment usually,” he said at SuperReturn. The specter of financial tightening as the European Central Bank or investment company ends its Quantitative Easing program is regularly highlighted as the largest risk facing the market this year, among many, as global tensions rise.

While private collateral firms and bankers are aware that they are near the top of the market, benign borrowing conditions could persist for some right time, allowing debtors to lock in cheap personal debt. “Borrowers are enjoying peak financing conditions,” said Ed Eyerman, head of European leveraged fund at Fitch in London. Comparisons with 2007 overlook the reality that the leveraged loan market has fundamentally transformed credited to covenant-lite lending – which did not exist about ten years ago – and a larger and more diverse institutional buy side. Although the lack of covenants is causing concern, bankers point to Spanish fashion dealer Cortefiel’s 2014 expansion and amendment of €1.4bn of debt and 25% covenant headroom increases.

This bought time for the operating business to boost and allowed Cortefiel to come back to your debt markets last year, but other companies might not be so lucky. “Cortefiel was the poster child for on-lite lending nevertheless, you can’t assume all will do that well,” a market analyst said. Co-president Scott Sperling said that Thomas H. Lee Partners is focusing on less cyclical growth businesses which are better situated to weather a downturn that could have a similar magnitude to the last financial crisis.

“It’s definitely not a brave ” new world ” that includes no routine,” he said. The global macroeconomic backdrop is also stronger than 2007 and private equity firms are continuing to reap the benefits of broad-based global financial growth, Sperling, and Eyerman said. Interest levels are rising but are anticipated to remain lower for longer than before the financial meltdown, which is unlikely to affect companies’ debt-servicing ability in the short term.

Fixed charge cover ratios, which measure how easily businesses can meet operating costs, are higher in leveraged companies than prior to the turmoil also. The type of companies borrowing has also changed with the rise of software and business services with fewer assets and higher free cash flow margins, that want less onerous credit protections, Eyerman said. “They don’t have the cake and fixed costs of pre-2007 leveraged credits in industries such as auto source and building materials,” he said.

Despite lower personal debt servicing costs, some still think the market’s record-nine-year bull run is merely delaying the inevitable modification, that may only make it more unpleasant. “We’re watching a movie where we know what the finishing is,” said Guthrie Stewart, global head of private investments at PSP Investments. It’s interesting, the article ends with a quotation from Guthrie Stewart, global head of private investments at PSP.

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