Private Equity to Get Squeezed Out of Another Stimulus Program – ValueWalk Premium
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Private Equity to Get Squeezed Out of Another Stimulus Program

Private equity’s decade-long debt binge is coming back to haunt it when it comes to obtaining the U.S. government’s coronavirus aid.

Q1 2020 hedge fund letters, conferences and more

Already largely shut out of the popular small business rescue loan program, the industry is now realizing that it’s likely to be excluded from the Federal Reserve’s $600 billion lending initiative because it bars companies that have loaded up on borrowed money. The prohibition strikes at the heart of the buyout-shop business model, where firms saddle the companies they purchase with debt in order to mint bigger profits on their investments.

Though the Fed’s “Main Street” lending facility for mid-size businesses doesn’t specifically preclude private equity-owned companies, executives say they’ve concluded that the tough terms will prevent many of their firms from qualifying. Some politicians and investors say that may not be a bad thing, especially because taxpayer dollars are on the line.

“It’d be teaching irresponsible risk takers to take irresponsible risks” if the Fed signed-off on loans to these companies, said Arena Investors Chief Executive Officer Daniel Zwirn. “You don’t have to be a math genius” to know how highly leveraged private-equity buyouts have been in recent years.

Private equity has used debt as jet fuel for acquisitions because ultra low interest rates have made financing cheap and easy to obtain. It’s a lucrative strategy because the more firms rely on borrowed money, the less cash they have to put up and the higher the returns. As leverage on deals increased and safeguards protecting lenders eroded, regulators began sounding alarms. But the practice continued with many on Wall Street saying it was just pushed to less regulated shadow banks.

A Great Run for Deals

Private-equity firms have completed more than 15,000 buyouts since 2010, including almost 2,000 in 2018, data compiled by Bloomberg shows. Private-equity firms that focus on smaller middle-market companies inked a record $500 billion of deals in 2019, according to data provider PitchBook. As of last year, leveraged buyouts had left purchased companies with $119 billion of borrowed money, including debt those businesses may have held prior to the acquisitions, according to Covenant Review data.

In the Main Street program, loans top out at $150 million and will be distributed by banks and then purchased by the Fed. For a business taking out a new loan, its existing leverage can’t exceed four times its 2019 earnings before interest, taxes, depreciation and amortization. If a company wants to add to an existing bank loan, its debt load can’t be more than six times Ebitda.

Read the full article here by Robert Schmidt, Jesse Hamilton and Sally Bakewell – Advisor Perspectives

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