The State of Private Equity

Apollo's Leon Black (#6 on the latest private equity league table) kicked off an interesting discussion on the private equity panel this morning, when he said that the backlog of leveraged loans held by banks has come down from over $300 billion to $125 billion now. It's halved in the past month, he said, and it should be cleared entirely in the next few months, at which point the banks will start lending again.

"The banks are open for the right deal, even today, and even in size," said Black, pointing to the Mars-Wrigley deal.

Thomas Lee (#32), on the other hand, was more skeptical: "I'm not sure the banks will be lending until the CLO market comes back," he said. Just like in the mortgage-origination industry, the banks were all happy to lend just so long as they weren't going to be keeping any of the debt on their own balance sheet; now that the securitization market seems to be completely broken, it's a very different world.

David Jackson, of Dubai's Istithmar World Capital, sided with Black "There's an attention deficit disorder on Wall Street," he said, and as soon as the backlog clears, they'll be lending again.

It fell to David Solomon of Goldman Sachs to respond, basically agreeing with Lee. "The capital structures will fit investors' appetites to hold risk," he said, and while there's still clearly appetite at the bottom of the capital structure, from things like PIPEs, the appetite for leveraged loans, which was largely fueled by the growth of CLOs and other structured securitization deals, is much more limited. "I don't think there' won't be a $20 billion deal over the next five years," he said, "but those transactions are going to be hard to execute."

Black, an equity investor by nature, was cautious. He's been buying (back) debt of late, because he thinks that equity is overvalued relative to debt. "The credit markets have been priced at a recession level and the equity markets haven't: the math just doesn't work if you look at these price levels," he said. "Until prices come down, those deals aren't going to happen."

But those prices are on bigger, public companies. In the mid-market space, where Lee is playing, there are still attractive deals, he said, in sizes of between $300 million and $2 billion. What's more, they can be financed: one bank told him that its balance sheet is wide open, up to $1 billion. And the debt isn't that expensive, either: "the spread is higher, but at these low rates we're actually spending less money for it," said Lee.

And of course not all private-equity deals need debt: some need none at all. Black invested $4 billion into Norwegian Cruise Lines to bolster their balance sheet: a deal which required no debt or credit. Still, he said, "the conventional buyout business" is slowing down, at least in the US.

Brazil, however, is a different story, said Jackson. Private-equity shops are being set up in Brazil by sophisticated and experienced financiers who have worked at places like Goldman Sachs, and they're getting local Brazilian banks to do leveraged loans. "You can find people in Sao Paulo or Mumbai who know how to do this kind of stuff," said Jackson. Brazilian banks, of course, are awash in liquidity, and haven't had anything like the balance-sheet problems experienced by their northern-hemisphere counterparts.

Black ended the panel by saying that it's very difficult to do a financial and operating turnaround simultaneously: "in our experience that's a recipe for disaster," he said, although he did concede that others, like David Bonderman in the airline industry, have managed to make it work in the past.

If private-equity shops were doing operating turnarounds last year, with the help of cheap finance, this year they might be concentrating more on financial turnarounds, buying the distressed debt of good companies with overly-leveraged balance sheets. That said, Jackson and Lee seem to be looking still for the operating-turnaround stories, albeit at a smaller scale than before. Either way, it seems, opportunities abound, for that small group of investors which still has a substantial risk appetite: if there's one thing the market still has in abundance, it's risk.