Last December, about a fortnight before officials in Wuhan began telling of a strange sickness that was filling the city’s hospitals, executives at the Carlyle Group worked into the night to sign what they imagined would be one of the private equity firm’s most enduring deals.
They were buying a stake in the corporate travel business of American Express, and promising to hold on to it for at least a decade — a departure for a firm that was founded in the 1980s on the industry playbook of buying companies cheap and selling fast. Like other big Wall Street firms, Carlyle had taken to promising investors stability instead of trying to wow them with the prospect of profits that came in spectacular bursts.
In 2020, however, there may be no such thing as a stable business, and Carlyle is now trying to walk away from the Amex deal before any money has even changed hands. The ensuing legal row has become a financial flashpoint of the crisis — one with far-reaching implications for a private equity industry that is sitting on $1.4tn of “dry powder”, according to data from Preqin, and facing pressure from investors to put that money to work.
At the heart of the dispute is a transaction that valued Amex Global Business Travel at $5bn. During a decade-long spell of economic growth, the agency’s 10,000 “travel counsellors” reaped hefty incentive fees from airlines by providing them access to a corporate clientele that wanted to travel in style. Carlyle struck a deal to replace some of the investors who bought in when American Express spun off the business in 2014, agreeing to pay $450m, according to people familiar with the terms — a fivefold increase on the valuation in the original deal.
A 33-page presentation persuaded Carlyle’s top executives to approve the transaction. The document, described to the Financial Times by multiple people who have seen it, was a catalogue of seemingly safe assumptions. As the travel agency grew, Carlyle reasoned that airlines would pay even more generous incentives. That process might be accelerated if one or two large competitors could be acquired from their ageing owners. Carlyle would itself become a loyal client; shuffling executives between offices in 21 countries, and signing up portfolio companies around the world as well, the firm reckoned its business could be worth tens of millions of dollars.
The investment team had even prepared for a recession — although, like many in finance, they seemed to view the chance of a big downturn as remote. (“If you thought 2008 was coming,” an executive at one of Carlyle’s rivals confided last autumn, “you probably wouldn’t look at a single deal we’re doing.”) Travel agencies can readily shed jobs or find other ways to cut costs, and the Carlyle executives calculated that their investment could withstand a downturn that was about 40 per cent the strength of 2008, according to multiple people who requested anonymity to discuss an internal document.
Carlyle’s assumptions were unable to survive February. On the last Wednesday of the month, federal officials warned that coronavirus-related disruption was coming to the US, and stock indices plunged. Within hours, the Carlyle team was reconsidering a leveraged bet on corporate travel that had been intended to carry them through the decade.
Their early moves seemed to aim at shunting risk on to Credit Suisse and other lenders who were being asked to sign on to the deal. One Carlyle executive asked whether pandemic-related losses could be excluded from the travel agency’s earnings calculations, a contractual change that could have prevented lenders from calling in their debt even if bookings deteriorated rapidly. Rather than refer to the virus by name in legal documents, the executive suggested negotiating a catch-all exclusion that would cover any unusual or extraordinary event, according to people with knowledge of the conversations.
Ultimately, Carlyle, which declined to comment for this article, decided on a more drastic course. The scene was set at the end of March, GBT sent out a financial update that the private equity firm found “shocking”. Nine days later, Tyler Zachem, a New York-based managing director who leads the firm’s long-duration funds, told executives at the travel agency that an “adverse event” appeared to have occurred, which, if true, could allow Carlyle to walk away without penalty.
The dispute is now in the courts. Carlyle says the sellers have violated several terms of the purchase agreement; the sellers retort that Carlyle and its co-investor, the Singaporean sovereign wealth fund GIC, reneged on their commitments after suffering buyer’s remorse.
In any case, the deal is unlikely to be completed. On June 30, an international syndicate of lenders are entitled to pull the transaction’s financing. This month, a Delaware judge declined to intervene in the case before the deadline, dashing the sellers’ hope of securing a legal victory in time to save the transaction.
“I cannot order time to stop . . . and I cannot, obviously, end the Covid-19 pandemic,” said Joseph Slights of the state’s chancery court, which resolves disputes involving the large number of companies based in Delaware.
For the AMEX travel business, the collapse of the deal means losing access to $1.1bn of debt financing at an ominous moment. US airlines are eyeing a second government rescue, and AMEX had been planning to keep some of the borrowed cash in case it needed it, instead of distributing it to shareholders as originally planned. Carlyle calls that a backdoor bailout — another reason, it says, why it is not obliged to go ahead with the deal.
The acrimonious ending to the partnership also complicates Carlyle’s plans to show that private equity firms — having attained fame as corporate raiders — can be a force for stability. Five years after launching its “long-term capital” platform, Carlyle is trying to sign up investors for CGP II, its second fund dedicated to the strategy, which was to have supplied some of the cash for the AMEX deal. Other firms with private equity vehicles dedicated to longer-term deals include industry leader Blackstone, and KKR, which has nearly $10bn earmarked for the strategy.
It will take months before a court decides whether CGP II must bear any liabilities related to the AMEX deal. Walking away at least means that any new investors who sign up will not be forced to pay full freight for a travel agency whose value would almost certainly have been impaired the instant the deal had closed. Meanwhile, Carlyle’s earlier long-duration vehicle, CGP I, which has put money into coronavirus-hit sectors such as jet leasing and events, has seen its value fall sharply enough to wipe out the performance fees that Carlyle had booked from the fund’s past gains.
Questioned about the poor performance on an investor call last month, Carlyle’s chief financial officer, Curtis Buser, tried to sound hopeful. “The long-dated fund’s got a long time for this to play out,” he said.