LBO debt gluttons have now gorged on equity too

December 23, 2011

By Jeffrey Goldfarb

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Leveraged buyout kings renowned for their debt gluttony have now gorged on equity, too. They’re sitting on nearly $400 billion of cash committed by investors, according to Preqin, or more than $1 trillion of purchasing power. A big slug of it belongs to mega-buyout funds that are already at or approaching their use-by date.

For a fourth consecutive year in 2011, private equity firms have been starved of larger acquisitions. Apax’s $6.3 billion purchase of Kinetic Concepts was among the few big deals this year. In 2007 alone, the volume of global leveraged buyouts larger than $500 million each was $450 billion, according to Thomson Reuters. For the last four years combined, it was around $300 billion.

Meanwhile, limited partners – the pension funds and other investors in private equity – keep bellying up to the buyout bar in hopes of securing better returns than are available elsewhere. And LBO firms have mostly been happy to accept the funds and the lucrative management fees they bring.

The typical buyout fund has five years to invest the capital committed to it. That means voracious fundraising in the boom years of 2006 to 2008 is still having an effect. Some $125 billion from the era remains to be deployed, Preqin estimates. Blackstone’s sixth fund, for example, first closed in 2008 with about $7 billion. It now has some $16 billion, but didn’t invest any of it until this year.

The firms have options. They can ask investors to extend the life of funds. They can also return capital, as Oaktree did earlier this year when it gave back some $3 billion of a $10 billion distressed fund. But it takes unusual financiers to surrender so much fee income. Instead, there’s a real risk that discipline is lost as private equity dealmakers try to deploy their so-called dry powder before it goes poof.

The sight of buyout firms falling over themselves for a minority stake in beleaguered Yahoo looks a possible case in point. And KKR writing an equity check for more than half the price of its $7.2 billion acquisition of Samson could be another. The eyes – and cash piles – of buyout barons may have grown too big for their stomachs.

Predictions: Breakingviews is publishing a series of articles over the holiday that look ahead to 2012. The pieces will be collected together in the annual ’Predictions Book,’ produced in print and electronic form early in the New Year.

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