(Bloomberg) - Some of the world’s top private equity firms are scooping up the debt of their own portfolio companies from banks at steep discounts as they seek juicy returns amid a lull in deal making.
Advent International Corp. recently bought a portion of a loan that helped fund its buyout of a Royal DSM unit, while Clayton Dubilier & Rice has purchased debt supporting at least two of its deals over the past year. Just last week Elliott Investment Management snapped up a $550 million chunk of bonds backing its acquisition of Citrix Systems Inc. at 79 cents on the dollar, following a similar move in September.
The trades come as banks have stepped up efforts to offload billions of dollars of debt stuck on their balance sheets — the product of a sharp repricing of risk assets last year that upended underwriting pledges. With Wall Street willing to realize significant losses in some cases to shed the risk, buyout firms coming off the weakest quarter for M&A since 2020 are finding the often double-digit yields on debt of companies they’re already well acquainted with too good to pass up.
“A lot of these private equity firms are smart buyers of debt when the time is right,” said Steven Messina, head of the banking group at Skadden, Arps, Slate, Meagher & Flom LLP in its New York office. “Right now, we’re in a situation where private equity firms generally are flush with cash and have the ability to take advantage of situations where the debt is trading at a discount.”
Representatives for Advent, CD&R and Elliott declined to comment.
When firms buy the debt at the sponsor level, it’s generally held as an investment. This allows them to profit from the interest payments, as well as any potential refinancing, sale of the company or initial public offering, wherein the debt gets repaid at around par. Sometimes it’s bought via an investment firm’s credit arm, which are often managed separately from the private equity unit.
Alternatively, the debt can be purchased by the portfolio company itself, in which case it’s usually canceled, cutting future interest costs while reducing leverage.
Either way, the wager is far from a sure thing. The Federal Reserve continues to raise interest rates to tame runaway inflation, while a potential recession in the coming months could weigh on corporate earnings, denting already depressed prices for risky debt.
“Private equity is expanding into other venues and looking at different ways to carve up the carcass,” said John McClain, portfolio manager at Brandywine Global Investment Management. “There’s a concentration of single-name risk.”
‘Positive Signal’
Still, the appeal is plain to see.
Elliott last week bought $550 million of second-lien bonds that are part of a $15 billion debt package banks underwrote to finance its buyout of Citrix with Vista Equity Partners. The bonds have a 9% coupon and were sold at a price of 79 cents, bringing the all-in yield to roughly 14%.
The firm made a similar trade last year, buying about $1 billion of Citrix’s first-lien junk bonds from banks at around 83.6 cents on the dollar.
Vista’s credit arm also bought a $200 million slice of the second-lien bonds, Bloomberg reported. A representative for the firm declined to comment.
“Buying the debt of a portfolio company at a discount is an interesting way of potentially creating more equity value at a cheaper level,” said Brad Rogoff, head of fixed-income research at Barclays Plc. “If you liked it at one price, you probably like it more at a cheaper price.”
There are often also other incentives for purchasing portfolio company debt, according to CreditSights’s global head of strategy Winnie Cisar.
Private equity firms may value the stronger negotiating position being a creditor affords should the company need to amend or extend its debt, especially if the economic outlook worsens, she said. Buying their portfolio company debt also sends a strong message to existing and potential lenders that the sponsor has conviction in the investment.
“That’s a very positive signal to other investors,” said Cisar. “That lends some reassurance.”
For some firms, part of the rational is undoubtedly about maintaining strong relationships with Wall Street leveraged finance desks, industry insiders say.
CD&R bought a $475 million slice of debt backing its purchase of a majority stake in Roper Technologies Inc.’s industrial operations business in November, relieving some of the burden on its bank lenders. The second-lien loan was offered at around 90 cents, according to people familiar with the matter who asked not to be identified discussing a private transaction.
It also bought roughly $464 million of risky payment-in-kind notes backing its acquisition of Cornerstone Building Brands Inc. at a discount of about 60 cents mid-last year, the people said.
Buying junior debt of portfolio companies can also make it easier for underwriters to place senior debt down the road.
More Bargains
In Europe, Advent International recently purchased the equivalent of €450 million of debt backing its buyout of Royal DSM’s engineering materials business, which lenders underwrote a year ago. Banks sold the remainder of debt at a discounted price of 90 cents just before it was considered hung, and Advent was likely able to secure slightly better terms as an early anchor order, market watchers say.
Going forward, there are likely to be fewer opportunities to scoop up portfolio company debt at discounted prices as banks continue to chip away at the pile of hung debt on their balance sheet, according to Barclays’s Rogoff. Others say a steady stream of new deals pricing with attractive discounts will continue to lure buyout firms.
Private equity could also increasingly turn to the secondary market in search of bargains, especially if high-yield bond and leveraged loan prices remain depressed, Rogoff added.
Some firms are already doing just that. KKR & Co.-owned Upfield bought its own Polish zloty and sterling debt worth about €250 million in recent months, according to a person familiar with the matter, canceling the debt and reducing its interest burden.
KKR declined to comment.
“There will continue to be secondary-market opportunities that companies can take advantage of,” CreditSights’s Cisar said.
(Updates with Americas stories in “Elsewhere in credit markets” section)
By Claire Ruckin and Paula Seligson
With assistance from Gowri Gurumurthy and Allison McNeely
April 12, 2023
