Private equity firms fight for lifeline deals

With buyouts at a virtual standstill, private equity firms are finding a new place to put their billions of dollars: investing in public companies that have been pummeled by the COVID-19 economic collapse.

The technique is a throwback to the 2008 financial crisis when, in one notable deal, Warren Buffett threw a $5 billion lifeline to Goldman Sachs Group Inc. This time around, it's gotten so popular that the bidding for slices of distressed companies can resemble a heated takeover battle, with as many as 20 private equity firms clamoring for a piece of one deal.

The fever underscores the huge amount of money buyout shops are sitting on — some $1.5 trillion, compared to $615 billion a decade ago — and the dwindling number of traditional buyouts available. The firms are betting that struggling companies such as Cheesecake Factory Inc. and Expedia Group Inc. will recover once the economy opens up.

Yet the competition for the deals has forced some firms to lower their typically high sights. Nowadays, they are shooting for an internal rate of return in the midteens to low 20%, down from 30% to 40% before March, according to estimates by dealmakers.

"There's so much committed capital trying to find investment opportunities, the processes are highly competitive and terms are reflective of that," Leo Greenberg, an attorney at Kirkland & Ellis, said.

Since late March, companies have raised about $8 billion from buyout shops in negotiated deals known as a PIPE — private investment in public equity. While buyout shops are typically in business to buy companies outright, these deals instead get them fat dividends and eventually an equity stake.

For struggling companies, PIPE financing still isn't cheap. But with their stocks depressed, they may have little choice other than to turn to private money. And at the very least, the competition among buyout shops affords them an opportunity to negotiate terms more favorable than existed before the COVID-19 crisis.

Cheesecake Factory, whose restaurant dining rooms are shut but providing takeout, spoke to about 20 parties before agreeing to a $200 million convertible preferred stock investment from Roark Capital, according to a person with knowledge of the matter who asked not to be identified because the information was private.

Roark will get a dividend of 9.5% and can convert the preferred shares into common stock when the shares hit $22.23. Cheesecake Factory declined to comment.

Outfront Media Inc. spoke to about 10 parties and ultimately settled on Providence Equity Partners and Ares Management Corp. Ares was an attractive partner because it was already an investor in the industry though Clear Channel Outdoor Holdings Inc., a person familiar with the matter said. Outfront will pay Providence and Ares a 7% dividend on the preferred shares.

Furniture retailer Wayfair Inc. had also spoken to multiple parties before signing on to a $535 million investment with a group of investors including private equity firm Great Hill Partners, which had a stake when Wayfair was still a private company, a person familiar with the matter said. Wayfair declined to comment.

Both Wayfair and Outfront were able to strike deals that allowed for the investors to convert their shares to common stock at a significant premium to where their stocks are trading. That will mean less equity dilution at the time of conversion. Wayfair's deal sets a 43% premium above the stock price while Outfront's had a premium of about 39%, filings show. Outfront Media didn't immediately respond to requests for comment.

"PIPE transactions enable sponsors to selectively invest significant capital in companies they believe are fundamentally sound, well managed, trading at substantial discounts, and poised to recover more quickly than their competitors post-COVID," said lawyer Jeffrey Marell, who co-heads the mergers and acquisitions practice at Paul Weiss Rifkind Wharton & Garrison.

One of the largest deals since the crisis hit involved Expedia Group Inc. People familiar with the process said it was run like an M&A auction. The company spoke to multiple parties before Apollo Global Management Inc. and Silver Lake agreed to invest $1.2 billion in preferred stock that will pay a 9.5% dividend, plus rights to buy common stock. Expedia is also raising about $2 billion of private debt financing. A representative for Expedia declined to comment.

Private equity firms are not only competing against each other but sometimes also the public market, which can offer better terms to companies when it comes to issuing equity and debt. "'Competitive tension comes from other PIPE buyers and also public market financing alternatives," Michael Voris, head of global convertible-bond financing at Goldman Sachs, said.

Cruise line operator Carnival Corp., which raised $6 billion issuing a combination of debt, stocks and convertible notes, was in talks with Blackstone Group Inc. for financing before eventually settling on the public deal, according to people with knowledge of the matter. Carnival rejected Blackstone's proposal because it was more expensive than the public market, the people said. A representative for Blackstone declined to comment.

For all of the excitement over PIPEs at the moment, however, it'll likely be a short-lived diversion for most private equity firms, said David Chung, executive director at buyout firm HGGC. "For the vast majority of firms," he said, "if and when things get back to normal, they will shift their focus back to controlled deals."