Big not always better for private equity megadeals
When a group of private equity firms struck a €17.2bn deal to buy Thyssenkrupp’s lifts business last month — even as global stocks whipsawed on fears about the coronavirus outbreak — it became one of the biggest leveraged buyouts since the financial crisis.
The deal, led by Advent International and Cinven, is the latest sign that the era of the mega-deal has returned even if the outbreak of the disease stymies activity.
Buyout groups have raised record-sized funds from investors such as pension funds and sovereign wealth funds and as a result require bigger and bigger deals to put this money to work.
For the biggest pools “a small deal, even if it goes really well, is just not going to move the needle,” said Brenda Rainey, senior director of the private equity practice at Bain & Company, the consultancy. “There’s a limit to how many deals you want to invest in out of a large fund, because it comes down to how much bandwidth you have to manage it.”
Yet the biggest deals do not always generate the biggest returns. In the decade since, according to Cepres. the financial crisis, deals for companies valued at more than $10bn have returned $1.81 to investors for every dollar they put in, less than the $1.92 brought in when investing in targets valued at below $5bn, according to figures from Cepres, the investment analytics firm.
Mega-deals are complex and often involve so-called club deal arrangements, where several buyout firms team up to buy and run a company. Some of the most unsuccessful leveraged buyouts in history have fallen into that category, such as the 2007 deal by a consortium including TPG and KKR to buy Texas power company TXU, which filed for bankruptcy in 2014.
Other giant buyouts have had more success, albeit it sometimes via a rocky path. Blackstone took the hotel chain Hilton Worldwide private in a 2007 transaction worth $26bn and subsequently had to write down its investment by about 70 per cent at the height of the financial crisis.
That led to more capital injections and a debt restructuring before the alternative assets group relisted the company in 2013. Yet by the time Blackstone finally agreed to sell its remaining stake in 2018 after more than a decade of ownership, it was one of the most profitable deals in the company’s history.
Private equity groups have reduced the leverage in their post-crisis megadeals but not by much, the Cepres data show.
In the pre-crisis decade, deals worth more than $10bn used on average 1.8 times as much debt as equity, compared to 1.7 times in the decade since. The biggest deals tend to be more highly leveraged than the smallest ones.
That leads to a word of warning. Among private equity-owned companies bought in the 10 years before the crisis, the more highly-leveraged a deal was the worse it performed on average, the figures show — with the exception of deals with the very lowest debt levels.
For deals struck since the crisis, that has not yet been the case. “The question now is whether we will see that pattern return if there’s a new downturn,” said Chris Godfrey, president of Cepres.