Schwarzman, Kravis Cash Pile Grows With Risk of Reduced Returns
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Schwarzman, Kravis Cash Pile Grows With Risk of Reduced Returns
By Jason Kelly and Elizabeth Hester
April 29 (Bloomberg) — Leveraged-buyout titans Henry Kravis and Stephen Schwarzman are sitting on record amounts of investor cash that has yet to find anything approaching the industry’s benchmark returns.
Private-equity firms raised $163.5 billion in the first three months of 2008, the second-biggest quarter since London- based Private Equity Intelligence Ltd. started tracking the data in 2003. At the same time, they agreed to $62.2 billion of leveraged buyouts, down 69 percent from a year ago, as borrowing costs more than doubled, data compiled by Bloomberg show.
Unable to finance the takeovers of $5 billion or more that fueled an all-time high $735 billion in transactions last year, LBO firms are trying to compensate by purchasing minority stakes in publicly traded companies and leveraged loans. Without the benefits of size and leverage, these deals may drag down returns from the average 30 percent or more that their investors expect.
“It is uncharted territory,” said Benjamin Phillips, managing director of strategic analysis at New York-based Putnam Lovell, an investment-banking unit of Jefferies Group Inc. that specializes in financial services. While buyout firms typically look for 20 percent internal rates of return from investments, “it’s headed well south of 20 now,” he said.
A year ago, Kravis, the 64-year-old co-founder of New York- based Kohlberg Kravis Roberts & Co., was working with TPG Inc. to close the $32 billion purchase of Dallas-based TXU Corp., the largest U.S. leveraged buyout. This year, his biggest deals include buying $1.25 billion of notes from Legg Mason Inc. to shore up capital at the Baltimore-based money manager. The notes, convertible into cash or Legg Mason stock, pay 2.5 percent interest.
Deal Sizes Shrink
The largest LBO this year by Schwarzman’s Blackstone Group LP was of Richmond, Virginia-based food distributor Performance Food Group Co. for $1.2 billion. Blackstone also bought New York-based hedge-fund manager GSO Capital Partners LP in January for as much as $930 million. Schwarzman, 61, said at the time that the deal will increase his firm’s ability to bet on distressed bonds and loans, and manage debt funds.
“Some of the best returns in the private-equity business come from investments in difficult economic times,” said Peter Rose, a spokesman for New York-based Blackstone. The world’s largest buyout firm has committed about $3 billion in equity to deals since the credit crunch took hold in August, he said.
Mark Semer, a spokesman for KKR, the second-largest LBO firm, declined to comment.
While deal-making has ground to a halt, fundraising hasn’t skipped a beat. KKR closed a $17.6 billion fund, its largest, at the end of last year. Warburg Pincus LLC said on April 22 that it raised $15 billion for its biggest pool, exceeding the New York-based firm’s $12 billion goal.
`Tough World’
Blackstone gathered $21.7 billion for the industry’s biggest fund last year. TPG, the Fort Worth, Texas-based firm led by David Bonderman, is trying to raise more than $15 billion for a new fund.
“If you’re not putting money out, it’s going to be longer until you can give money back,” said Lyons Brewer, a managing director of C.P. Eaton Partners LLC, a Rowayton, Connecticut- based firm that helps hedge funds and private-equity firms raise capital. “It’s going to be a tough world for awhile.”
LBO firms use cash from investors combined with their own funds and debt secured on the target they buy to finance takeovers. They typically seek to expand companies or improve performance before selling them within five years. The use of debt, which can cover as much as two-thirds of the purchase price, helps boost returns.
Baseline for Returns
Buyout funds are invested over a period of five to 10 years, so the impact of today’s markets on returns won’t be known for some time. Past gains have far exceeded what investors have earned with stocks or bonds.
TPG Partners IV, a $5.3 billion fund started in 2003, has generated average annual returns for investors of more than 34 percent, according to data on the Web site of the California Public Employees’ Retirement System. KKR Millennium Fund, begun in 2002, also has returned 34 percent. Blackstone Capital Partners IV has advanced 54 percent a year since its 2003 debut, the Calpers site shows.
The LBO model has changed this year, with buyout firms stepping up to rescue banks and bond insurers crippled by losses from the collapse of the subprime-mortgage market. Instead of using leverage, the investors are buying in at large discounts to current market prices.
National City Corp., Ohio’s largest bank and subprime lender, sold $7 billion of equity last week to a group led by New York-based Corsair Capital LLC at 40 percent below the current share price.
Credit Cycle
TPG paid $2 billion for a 16 percent stake in Washington Mutual Inc. on April 8. The Seattle-based company, the largest U.S. savings and loan, sold the shares at a 33 percent discount to the previous day’s close.
Bonderman, 65, declined to comment. During its 16-year history, TPG has taken non-controlling stakes in companies including Oxford Health Plans Inc. and Continental Airlines Inc. The firm made about 10 times its $66 million investment in Houston-based Continental.
TPG remains among the most active buyout firms. The firm agreed earlier this month to buy 50 percent of SIA International Ltd., a Russian pharmaceutical company, for $800 million.
Private-equity investors are “seeing distressed debt-type valuations, which are attractive, for real businesses and real assets,” said Jeffery Harte, a Chicago-based analyst at Sandler O’Neill & Partners LP. “The current environment is really tough, but if you can fast-forward to when the credit cycle turns, these are good assets they’re buying on the cheap.”
MBIA Paper Loss
The strategy comes with risks. Warburg Pincus invested $500 million in MBIA Inc., the world’s biggest bond insurer. It paid $31 a share in January for stock in the Armonk, New York-based company that now trades at less than $10.
Buyout firms, which are accustomed to controlling the companies they acquire, have much less of a say when they take minority stakes. Instead, many of the deals give them dividend- paying preferred shares that can help boost returns.
“It is very different from investing in a traditional buyout,” Ignacio Jayanti, Corsair’s president, said in an interview last week. “You cannot use leverage in the same way, as the underlying companies are already very levered and regulations proscribe certain types of leverage common to traditional buyouts.”
LBO managers may be willing to trade higher returns for the opportunity to simply put money to work, said Christopher P. Giordano, an attorney at DLA Piper US LLP in New York, who advises private-equity firms.
“Funds are sitting on a significant amount of capital and there is expectation to deploy that,” Giordano said. “A return on equity invested that’s a positive is better than zero.”
To contact the reporters on this story: Jason Kelly in New York at jkelly14@bloomberg.net; Elizabeth Hester in New York at ehester@bloomberg.net
Last Updated: April 29, 2008 00:00 EDT