Sword swallowing
ANALYSIS: Market slide double-edged sword for private equity By Alison Tudor, Asia Private Equity Correspondent SYDNEY, March 6 (Reuters)
Global stock markets have been knocked in the past week by a variety of concerns, including a selloff in China's stock market and concerns about the strength of the U.S. economy.[Nevertheless, the private equity guys have recently held its annual global confab which concluded that Private Equity was not putting its best face forward to the public and Guambat would assume that that PR challenge was behind the following "spin" in the story:]
During a bull stock market private equity has been able to buy companies and flip them onto public markets in an initial public offering within two to three years, making money from rising valuations. This process is called multiple arbitrage. The value of IPOs in the Asia Pacific region rose 27 fold between 2002 and 2006 to $49.5 billion.
Private equity firms typically pay for companies with packages made up of about 30 percent equity and 70 percent debt.
Investment banks have been falling over each other to provide the debt on relatively easy terms, pushing the price tag of some buyouts to stratospheric levels, but there are growing signs that such borrowing may be getting more expensive as worries about the global economy make lenders more risk averse.
Higher debt levels loaded onto the acquired firms will make it harder for them to wring out profits and tougher to sell. "While the risk of default has gone up with the prospect of higher credit spreads, default does depend on how aggressively
the debt was structured," said Fitch's Loong.
"Interest coverage of between one or two times would translate to higher default risk in case of a sharp increase in interest costs," added Loong.
Usually about 75 percent of exposure to interest rate rises is hedged and private equity can also hedge foreign exchange risks, but the risk remains that portfolio companies will not generate enough cash flow to service quarterly interest payments.
"There is a big difference between not making a return of three times your money as per the investment plan and not having enough cash to repay the interest bill every quarter," said another general partner of a private equity fund in Sydney. "The really experienced buy-out guys would not put in place the sort of debt levels that were likely to end in monetary default."
"Stock market falls are a godsend for buying opportunities," said one private equity partner in Sydney who declined to be identified. "The silver lining is that buyout acquisition multiples might drop in line with the decline in public equity markets, which would be a refreshing change," said Siew Huey Loong, an analyst at ratings agency Fitch.
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