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November 16, 2009 12:00 AM

Here's why buyout firms are flooding IPO market

Arleen Jacobius
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    Chip East/Bloomberg News
    Repaying:

    Private equity firms are dolling up companies for initial public offering as a way of easing the $1 trillion of buyout debt weighing down their portfolios.

    Some of the biggest private equity firms are accessing the public markets this year, using the capital to deleverage their companies. Kohlberg Kravis Roberts & Co., Blackstone Group, Silver Lake Partners and Fortress Group Inc. all have taken or are taking portfolio companies public this year.

    KKR and Silver Lake used the public markets in August to launch Avago Technologies Finance Pte. Ltd., a Singapore-based semiconductor business spun out of Hewlett-Packard Co. The duo used most of the $648 million in proceeds to pay down leveraged buyout debt.

    KKR planned to do the same with the proceeds from Dollar General Corp., which went public in a $716.1 million offering last week.

    “The IPOs that are coming out now are not killer deals. They are not taking lots of money off the table,” said Harris Smith, Los Angeles-based managing partner of private equity at Grant Thornton LLP. “They are refinancing debt because they have to.”

    The plan is to use the IPO market, if it materializes, to reduce leverage because the public markets are more available than the credit markets are, Mr. Smith said.

    “A lot has been written about IPOs but nobody is making a killing,” he said.

    Blackstone plans to take eight companies public in the next 12 to 18 months “if equity markets remain stable,” Stephen A. Schwarzman, Blackstone chairman and CEO said in a Nov. 6 quarterly earnings conference call. Among the eight are Team Health Holdings Inc., which filed Oct. 6 to raise around $100 million, and Graham Packaging Co. Inc., which filed on Nov. 2 to raise $350 million. (In June 2008, Blackstone and Hicks Acquisition Co. announced they would take Graham public in a $3.2 billion deal, but that transaction failed earlier this year.)

    More launches

    Fortress took RailAmerica Inc. public Oct. 12, tapping the capital markets to pay down the $714 million in debt it loaded on when it took the company private in a $1.1 billion leveraged buyout in February 2007. It was the company's first IPO in more than two years, CEO Daniel H. Mudd said during Fortress' third quarter earnings call Nov. 6.

    Fortress executives expect to launch more IPOs in the next year as a way of accessing capital. “Lots of individual company performance ... has been exceptional, and where we think it makes sense for them to access incremental capital, the IPO markets are a very viable form of that,” Wesley Edens, chairman, said during the conference call. “So I think it's going to be an active period for us next year with regards to that.”

    Other firms also have nudged companies onto the market. Three buyout-backed companies went public in October to pay down debt: Cerberus Capital Management LP took portfolio company Talecris Biotherapeutics Holdings Corp. public, raising $950 million in the IPO; Bain Capital LLC did the same for Dollarama Group LP, using the C$300 million (US$286.5 million) proceeds to pay down debt; and TPG's Australian department store, Myer Group, raised A$2.4 billion (US$2.2 billion).

    Executives at private equity firms deny they are being pushed to take portfolio companies public to distribute some capital back to investors, who have seen little in the way of distributions since the economic crisis began. Instead of using IPOs to exit investments, the managers say, they are using the public markets, to take some of the massive buyout debt off of their portfolio companies' backs.

    Both Mr. Schwartzman and Hamilton “Tony” James, Blackstone's president and COO, said they plan to continue owning most of the companies for years to come.

    “I mean, let's face it. The stock market has had a heck of a run,” Mr. James said. “So, I'd say we've accelerated some of our plans ... and it doesn't seem to us imprudent to derisk some of these companies, delever them, take some money off the table and send some money back to our” limited partners.

    Private equity firms are scrambling to pay off debt because the credit markets are closed to them and banks are requiring additional capital to extend loans. A number of these LBOs already are in trouble.

    Private-equity-backed companies are more likely to be in distress, with a fifth of 186 buyouts having a rating of B3 or lower, according to a study released earlier this month by Moody's Investors Service. A lower rating indicates a higher likelihood of default. Six of the 10 largest leveraged buyout deals in the past 21 months are either in distress or have defaulted, according to Moody's.

    In addition, the rating agency expects another large buyout target — Energy Future Holdings, the former TXU Corp. — to default shortly. On Nov. 12, Energy Future exchanged $357.5 million in debt for equity, below its $3 billion target. KKR and TPG led the consortium that took the company private in 2007 in a record-setting $45 billion leveraged buyout.

    “We are also pessimistic about the increased likelihood of default among our study group of 186 companies; refinancing risk is growing, with most revolvers set to expire in 2011 and 2012,” the study concludes.

    Default or breach

    A recent survey by Grant Thornton shows that 85% of general partners expect to default or breach a covenant on their debt. Grant Thornton surveyed more than 100 private equity executives.

    Industry insiders say the private equity industry will have to return to basics, with less debt, smaller companies and longer holding periods. In the meantime, private equity firms are trying to take their portfolio companies public in order to pay down the massive amount of debt on their books.

    Most private equity firms are concentrating on their portfolios, said Dominique Senequier, CEO of global private equity firm AXA Private Equity, Paris. The firm manages $26 billion in direct, funds of funds and secondary market funds.

    “There is so much debt they have to fight to survive,” said Antoine Dréan, CEO of Triago, a Paris-based global placement agency. According to estimates by his firm, $500 billion to $1 trillion of buyout debt is in need of restructuring.

    “I have a lot of admiration for the buyout people,” Ms. Senequier said. “They are tough people. They sometimes take too much risk for my taste.”

    However, she added that it is to the firms' credit that they are taking measures to cut costs and pay down debt.

    Some firms are set to profit from the buyout debt: Fortress executives said that their credit funds have been buying up debt that the buyout groups heaped on companies.

    “Our credit funds have been a big beneficiary of the messy environment as individual assets and larger portfolios have come out of troubled capital structures and Fortress has stepped in as an acquirer manager,” said Fortress CEO Mr. Mudd.

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