By JULIE CRESWELL and PETER LATTMAN
THIS summer, executives from the New York-based private equity firm SK Capital traveled to Houston to celebrate the first anniversary of their acquisition of a nylon manufacturing business. Soon they will have a bigger reason to uncork the Champagne.
The nylon manufacturer has announced plans to issue about $1 billion in debt, of which $922 million will be used to pay a dividend to SK. For SK, which paid $50 million in cash for the business, that is an astonishing almost 18-fold return in a little more than a year.
Yes, Wall Street's buyout barons, bruised and battered in the financial crisis, are back.
The private equity industry has emerged from a treacherous two years on relatively solid footing. Default rates among the companies they control have dropped sharply and many have tapped into robust debt markets to push back the huge amounts of debt coming due in the next couple of years.
And private equity's deal-making machine is revving up again. Last month, 3G Capital struck a deal to take Burger King private in a $3.3 billion leveraged buyout. Other firms are prepping holdings for initial public offerings so they can return capital to their investors, who have seen little in the way of profits in recent years.
"It's astonishing how quickly it's turned," said Kirk Radke, a lawyer with Kirkland & Ellis. "Most people a year ago were focused on their portfolio companies and internally focused. What we're seeing now, across the board, is that our clients are very busy."
The New York TimesPrivate equity, however, may soon be facing its gravest challenge yet. Its most important constituents "” the large public pension funds that provide it with more than half its capital "” are weighing whether or not to stick with private equity in the coming years.
"The big test is how the investments made during the boom are going to play out and it's too soon to tell," said Joseph Dear, chief investment officer for the California Public Employees' Retirement System, the nation's largest state pension fund. Calpers has significant exposure to the mega-buyouts struck between 2005 and 2007, which have largely languished during the economic slowdown.
"If the capital structures in those deals hold together, the returns will be good and demand will be strong. If the economic scenario worsens, and the returns are poor, investors will turn away from private equity," Mr. Dear said.
As deal activity has picked up, some private equity firms are turning to transactions whose merits have come under some criticism from their investor base.
Among them are so-called secondary buyouts, which involves passing a company from one private equity firm to another. There have been a flurry of these transactions this year, amounting to a record 25 percent of the value of all private equity deals, according to Thomson Reuters.
Recent large secondary buyouts include the Carlyle Group's sale of the health care company MultiPlan to BC Partners and Silver Lake for $3.1 billion and Bain Capital's $1 billion acquisition of Air Medical from Brockway Moran & Partners and MVP Capital Partners.
These deals hold great appeal in the private equity ecosystem, allowing sellers to book profits and buyers to deploy their billions of dollars of unused capital.
Investment banks, meanwhile, earn big fees on these deals by advising and lending money to finance the transactions.
Secondary buyouts also tend to be more expedient than the traditional route of an initial public offering, with its regulatory hassles and the vagaries of the market, or selling to a publicly traded company whose shareholders may object.
But secondary buyouts have a mixed reputation among private equity investors. The world's largest private equity firms share the same investor base: American public pension funds and foreign countries' investment vehicles, or sovereign wealth funds. In some instances, these investors are selling a company through one private equity firm and buying it "” at a higher price "” through another firm.
Calpers experienced this firsthand this summer, when the buyout shop TPG acquired Vertafore for $1.4 billion from the private equity firm Hellman & Friedman, which had owned the software provider since 2004. Hellman & Friedman and its co-owner, JMI Equity, earned more than four times their original investment on the deal. Calpers has big stakes in both the TPG fund that bought Vertafore and the Hellman & Friedman fund that bought it.
Mr. Dear, Calpers's chief investment officer, said he had mixed emotions about the Vertafore deal and other similar ones in his portfolio.
"We still have exposure to the company but at a higher valuation," Mr. Dear said. "To me this isn't a sign of strength in the private equity business, but more a sign that firms must commit their capital before their investment period runs out."
A spokesman for TPG declined to comment.
Margot Wirth, director of private equity investments at the California State Teachers' Retirement System, or Calstrs, the nation's second-largest pension fund, says she is also concerned about the increased number of these deals.
"Where we tend to scratch our heads is where a company is passed between two large firms with similar characteristics and skill sets," she said. "You have to ask, what performance improvements will the new owners be able to make to the company that the previous owners already haven't made?"
Another hot button among the industry's critics is the resurgence of the dividend deal, or dividend recap.
This spring, Visant, the private equity-owned company that owns Jostens, the purveyor of yearbooks and school rings, issued debt to pay a dividend of $137 million to its owners, Kohlberg Kravis Roberts and a buyout unit of Credit Suisse.
After efforts to sell the company failed, Visant issued a $1.25 billion term loan, of which $517 million was earmarked for another dividend payment. Taken with a similar deal in early 2006, K.K.R. and Credit Suisse have collected nearly $1 billion in dividends from Visant in recent years. K.K.R. and Credit Suisse declined to comment.
About 56 private equity-supported companies have issued about $23 billion in dividend debt this year, according to Leveraged Commentary & Data, a division of Standard & Poor's. On average, the dividends are returning the private equity firm's original investment, say analysts at the firm.
"From the private equity standpoint, the benefits are clear," said Steven Miller, managing director of Standard & Poor's L.C.D.. "You get to take money off the table "” in some cases, get all of your bait back "” and you maintain your ownership of the company."
At SK Capital, which invests primarily its own executives' money, the decision to issue the dividend-paying debt was partly based on the expected jump in tax rates on dividends that go into effect next year, said the firm's co-founder, Barry Siadat. He also says SK so improved the nylon manufacturer's operations that it can easily handle its new low levels of debt.
But critics of these so-called dividend recap deals say they only add strain, in terms of borrowed funds on the balance sheets of companies, at a time when the economic outlook remains cloudy.
"Dividend recaps are a concern and we definitely monitor them," Mr. Dear of Calpers said. "If the economy sours from here, private equity firms could be looking at more distressed situations or possible bankruptcies."
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E-mail This Print Share Close Linkedin Digg Facebook Mixx My Space new_york_times:http://dealbook.blogs.nytimes.com/2010/09/29/private-equity-thrives-again-but-dark-shadows-loom/ Permalink Financial Services, Special Section Fall 2010, 3G Capital, Air Medical Group, Bain Capital, BC Partners, Brockway Moran & Partners, Burger King Holdings, CalPERS, Calstrs, Carlyle Group, Credit Suisse, Hellman & Friedman, JMI Equity, Kohlberg Kravis Roberts & Co., MultiPlan, MVP Capital Partners, Silver Lake, SK Capital, TPG/Texas Pacific Group, Vertafore, Visant Related Posts From DealBook K.K.R. Could Borrow $11 Billion for Coles BidBain Said to Buy Air MedicalTPG to Pay $1.4 Billion to Buy Vertafore off RivalsPrivate Equity Firms to Sit Down With Investors, Report SaysSchwarzman Sees Buyout ‘Chill’ in Australia Previous post The Regulatory Pregame: Laying Bets on the Winners Next post Special Section: Tests for Buyout Firms and Banks NYTD.CRNR.userContent.getUserContent(25,'default'); Latest DealBook Headlines Ireland’s Bank Bailout Mounts, Swelling Deficit // TARP Ends Monday, But Some Hang On // Democrats Find Many Big Donors Cutting Support // Protests in Europe Lead to a Down Day // Two Are Confirmed for Fed’s Board // DealBook News by Industry Airlines / Autos Basic Industries Consumer Goods Energy / Utilities Financial Services Food & Beverage Healthcare Media Real Estate Retail / Leisure Technology Telecom Read Full Article »