Private Equity Alert
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Private Equity Alert January 2009 Fear and Greed Weil News By Doug Warner ([email protected]) and Michael Weisser (michael. n The 2009 Edition of Best [email protected]) Lawyers in America named our following partners in the areas Let’s cut to the chase. This past year was an annus horribilis for the private equity of Leveraged Buyouts, Private industry. The financial crisis that started with the credit crunch in the summer of Equity Law or Private Funds Law: 2007 and accelerated with the collapse or bailout of numerous financial institu- Christopher Aidun, David Duffell, Shukie Grossman, David Kreisler, tions worldwide in the fourth quarter of 2008 left many victims in the private Steven Peck, Charles Robins, equity industry in its wake. Jay Tabor, Jeffrey Tabak, Doug Warner, Glenn West, James Pundits have recently predicted that this financial crisis would result in a secular Westra and Barry Wolf change in the market for private equity with a significant percentage of private n Weil Gotshal advised Lehman equity funds going out of business and the industry materially shrinking. On the Brothers Holdings Inc. in other hand industry leaders have reminded investors that historically some of the connection with the management best private equity deals have been struck when times were gloomiest. Stephen buyout of Neuberger Berman and Schwarzman reportedly recently stated that he was a “raging bull” on private certain of its alternative asset equity. Guy Hands reportedly pointed out that if Wall Street had worked on a businesses “carry basis,” as private equity sponsors do, Wall Street may have avoided many of n Weil Gotshal advised NBC the transactions that have contributed to the current financial crisis. We are Universal Inc. in connection with the consummation of the $3.5 similarly bullish about the private equity industry and the vitality of the private billion acquisition of The Weather equity business model. Channel by NBC Universal Inc., The Blackstone Group and Bain Capital This article looks back on trends we saw in the industry in 2008. It also contains some predictions as to what awaits the industry in 2009 and beyond. n Weil Gotshal advised Providence Equity Partners in connection with its $290 million going private Trends in 2008 acquisition of eTelecare Global Some of the trends we saw in the private equity market in 2008 included: Solutions, Inc. n n Weil Gotshal advised Getty A Difficult Fund Raising Environment – The fund raising environment Images Inc. in connection with its atrophied in 2008. New funds had difficulty raising any capital and seasoned $2.4 billion public-to-private sale funds had difficulty reaching their targeted amounts of capital. Traditional LPs to Hellman & Friedman found themselves unable or unwilling to make new commitments given that n Weil Gotshal advised WL Ross & their allocations to alternative investments ballooned above their target alloca- Co. in connection with its $1.1 billion tions due to the so-called “denominator effect” of the decline in value of their acquisition of Option One Mortgage stock and bond portfolios and due to the drought in distributions by private Corporation from H&R Block equity funds to LPs. Certain LPs also had issues with funding their current n Weil Gotshal advised Advent commitments and formally or informally communicated to sponsors a desire to International Corporation in connection with its acquisition of defer capital calls to help them with cash flow issues or to reduce the overall size Hudson Group’s retail business of their commitments to the funds. Sponsors responded in various ways to n Weil Gotshal advised Avista retain the goodwill of LPs as well as to discourage the selling by LPs of their LP Capital Partners in connection interests on an already distressed secondary market. Permira, for example, with the $4.1 billion acquisition reportedly offered a “pre-packaged default” option to LPs whereby they would of the ConvaTec business unit of release LPs from 40% of their commitments in exchange for the LPs giving up Bristol-Myers Squibb Company Private Equity Alert January 2009 25% of the upside on their current sponsors were able to complete in healthy portfolio companies. The funded capital and paying full 2008 were all equity deals or deals name of the game for troubled management fees on their original where equity represented a majority portfolio companies was keeping commitment. TPG, on the other of the capital structure. them alive through equity cures, hand, reportedly offered to release credit agreement amendments, n Significant Decrease in LBO all LPs from up to 0% of their revolver drawdowns, PIK toggle Volume – The private equity capital commitments, reduce their exercises and debt exchange offers. industry suffered a 69% collapse in management fee by a tenth and not For healthy portfolio companies, the value of sponsor-backed buyouts to draw down more than 30% of an sponsors focused on add-on worldwide from 2007 and investor’s total commitment in acquisitions and opportunistic accounted for just 8% of worldwide 2009 without advisory committee buybacks of discounted debt. Many M&A transactions in 2008 approval. portfolio companies filed for compared to 8% in 2007. The bankrupty protection in 2008 and n The Great Fire Sale – This past year decline affected all sectors of the many remain on Standard & Poor’s witnessed a great fire sale by LPs of market, including mid-market “weakest links” list as most at risk interests in private equity funds, buyouts, and was a function of the of default. including brand name funds, at lack of available debt, the erosion of distressed prices. Advisory firm EBITDA at many target companies n The Law of Gravity – Private equity Cogent Partners recently reported and the difference in price expecta- sponsors discovered in 2008 that that pricing for LP interests in the tions between sellers and buyers. they were not immune to the secondary market declined to an economic reality affecting the average of 6% of NAV in the second We are bullish about the economy generally and some were half of 2008 compared to 85% in the faced with difficult decisions as to first half of 2008. The distressed private equity industry and the whether to lay off employees or pricing has both to do with uncer- vitality of the private equity scale back offices and global tainty over valuations for business model. ambitions. A number of private investments made by 2005, 2006 and equity sponsors did lay off 2007 vintage funds at or near the employees and close offices in 2008 n Continued Unraveling of Boom Era and headcount in the industry is top of the credit cycle, as well as a LBOs – A number of sponsors found significant supply-demand imbalance likely to continue shrinking in 2009. themselves in litigation with sellers between sellers and buyers. and lenders in 2008 over the Predictions for 2009 n A Great Sucking Sound – That great continued unraveling of some of Some of our predictions for the sucking sound you heard in 2008 the mega LBOs announced in 2007. private equity market in 2009 include: was of leverage leaving the system From cases like URI and Huntsman, as Wall Street banks, CLOs, CDOs, buy-side sponsors learned a number n Sponsors Continue to Manage LP hedge funds and mid-market of lessons, including making sure Liquidity Issues – We would expect lenders all largely shut down their that your reverse termination fee is that certain other sponsors will lending operations to private equity the seller’s sole and exclusive follow the lead of Permira and TPG sponsors and others. Lenders were remedy against you and that it is in 2009 in accommodating LP unwilling to originate new loans dangerous to rely on a material liquidity issues to both retain the due to concerns regarding their own adverse effect clause to walk away goodwill of LPs as well as to relieve solvency and the dampening effect from a transaction. The overriding some of the pressure on LPs to sell of performing senior leveraged lesson for sponsors is that careful LP interests in the secondary loans trading in the 60s and 70s in drafting and good lawyering do market. We would also not be the secondary market. This was matter when a deal doesn’t work surprised if certain sponsors face the notwithstanding the good news out as planned. prospect of LP defaults on capital that the pre-credit crunch leveraged calls in 2009. We would also expect loan overhang declined from a peak n Tending Your Garden – By the in 2009 to see the continued strong of $237 billion in July 2007 to second half of 2008, the primary interest by LPs in secondary sales of approximately $5 billion by year activity of many sponsors was their LP interests both to address end. Many of the buyouts that focusing on both their troubled and liquidity and rebalancing issues. Weil, Gotshal & Manges LLP 2 Private Equity Alert January 2009 n Reduced Private Equity Activity leveraged companies, such as banks, Looking Beyond the Abyss Continues – We don’t expect any acquisitions that are structured to Although there is still abundant fear quick or vigorous rebound in preserve existing leverage and in the market we agree with the private equity activity, particularly additional equity investments in private equity industry leaders who buyouts, in 2009. There are no existing portfolio companies. We believe that the market for the next signs that any significant lending also would expect that sponsors may 2 to 24 months will prove, in activity to sponsors to fund buyouts more frequently partner with hindsight, to have been a great market will resume in 2009. Wall Street strategic investors to enhance their to deploy capital before the pendulum banks are still paralyzed with fear access to whatever leverage is swings again and there is too much available and to engage in hostile and are mostly focused on capital chasing too few attractive transactions.