Private debt arms of private equity firms play a limited role in the manager’s deals
Private debt arms of private equity firms play a limited role in the manager’s deals
Leveraged buyouts have delivered strong returns to investors. The largest 25% of buyout funds delivered a lifetime median net IRR of 15.8% over the 2000-2019 period, the highest of any size group, according to new research on Preqin Insights+. Low interest rates and benign economic conditions have favored the buyout segment, both by driving additional capital into the asset class and in terms of the cost of finance for companies, where competition among leveraged lenders and debt funds has led to a borrower-friendly market.
But now the uncertain economic outlook, inflation, and specter of further interest rate rises are causing investors to look hard at the structure and economics of LBOs. The increasing use of private debt in LBO finance – direct lending AUM as a proportion of private equity AUM has risen from 7% to 17% over the past decade – means that buyouts are headed into uncharted territory. The prevalent floating-rate structures may mean investors do not lose out if interest rates rise, but companies will take a hit as rate rises are passed on. Concerns have been raised in a number of areas, including covenants and deals where the same fund manager provides both equity and debt.
Buyouts have been booming. The strategy saw record activity in 2021 as 3,065 deals were closed with an aggregate deal value of $401bn. Although this was not far above the 2,972 deals closed in 2017, the aggregate value then was just $223mn, meaning capital invested in 2021 has almost doubled over the past five years (Fig. 1).
Despite an increase in average deal size from $72mn in 2012 to $131mn in 2021, the number of large buyouts – in this case deals over $500mn – has remained fairly flat over the years. Indeed, the average over the past ten full years was 36 deals per year, with a peak of 52 in 2014 (Fig. 2).
As alternative assets have grown, the world’s largest buyout firms have diversified their product offering, with many managing private credit funds alongside private equity, real estate, and infrastructure funds. To what extent are these arms investing in the same deal? Of buyouts of over $500mn, 19 out of 359 deals (5.3%) from 2012 to 2021 had both equity and debt financing from the same manager.
Even where the equity and debt arms are investing together, they are seldom sole providers. With the $4.2bn Ultimate Fighting Championship Ltd buyout in 2016, KKR was one of a number of equity investors in the deal, alongside Silver Lake, WME IMG, and MSD Capital. Although financial details of the debt facilities were not disclosed, KKR Capital Markets provided debt, alongside Deutsche Securities, Owl Rock Capital Partners, Credit Suisse, Barclays, and Goldman Sachs Asset Management.
Of deals where the debt size is known and over $500mn, just seven out of 86 (8.0%) featured the same fund manager providing both debt and equity (Fig. 3). The $919mn buyout of VetPartners Limited in 2018 had $760mn of debt, with Ares Management the sole provider. Ares also provided equity, alongside BC Partners.
Preqin data indicates that the growth of the buyout market has been broad, rather than driven exclusively by increasing transaction size. Historically, terms and conditions have loosened as cycles have progressed, and the increased penetration of private debt finance adds a new element that will impact how a tougher economic environment will play out. But concerns that private equity fund managers are using debt funds from their own stable to provide overly favorable loans look – in the vast majority of cases – overblown.