A cautionary tale played out in the world of private equity last month when KKR disclosed a writedown on the value of its biggest investment, which had been burning a hole in its portfolio for years.
The buyout of First Data, a US payment company, had drained $300m from KKR’s balance sheet in the three months ended March.* The buyout group started to exit the deal last October, when it listed shares, but last quarter’s earnings included a $300m writedown, as stock market turbulence helped drag First Data’s shares down nearly a third since its listing.
Big private equity groups including KKR and Blackstone have called this year’s market volatility a great opportunity to snap up companies on the cheap. But it also means stock investors are more cautious about companies floated by buyout houses.
KKR’s First Data troubles are a reminder not just of heady valuations for large acquisitions near the top of the cycle, but also of prickly markets that can hurt the buyout groups with further mark-to-market losses once companies are floated.
“There’s no lack of desire for taking companies public or selling them,” says David Fann, chief executive at TorreyCove Capital Partners, which advises PE investors. “The concern is whether they can get it done in a choppy market. I don’t think anybody has confidence they could get a sizeable deal done.”
Risk aversion ruled at the start of the year, as global equity markets sold off and credit spreads widened. Initial public offerings all but dried up, including those from PE groups, as investors demanded bigger discounts to publicly traded peers.
In an environment of risk aversion, many of 2015’s listings have not performed well. At the market trough in February, investors in last year’s IPOs had lost an average of nearly 30 per cent, according to Renaissance Capital, which runs IPO-focused exchange traded funds.
“We had a very volatile market where the IPO market was just not healthy and anything with leverage was just that much more difficult,” says JD Moriarty, head of Americas equity capital markets at Bank of America Merrill Lynch.
Since then the market has rebounded, making up nearly all the ground lost at the start of the year, and 2015’s IPOs have narrowed losses to 16.5 per cent on average. This year’s deals are up 17 per cent.
The success of the recent IPOs such as American Renal Associates, which operates dialysis clinics, the first leveraged buyout since First Data, provides some optimism that the listings market is reopening.
ARA has net debt of 4.2 times earnings before interest, tax, depreciation and amortisation. The company, which was bought by Centerbridge, is trading at $28 from a listing price of $22.
With the equity rally stalled below last year’s high, investors remain cautious, however.
Bankers are advising sponsors not to list their most indebted companies, according to a person with knowledge of the conversations.
This year a handful of PE-related deals, including US Foods (owned by Clayton Dubilier & Rice and KKR), filed for IPOs. There is also a backlog, including the grocer Albertsons, carrying over from 2015. Among them SiteOne Landscape Supply, a distributor controlled by CDR, is expected to price its deal this week.
Another issue for more leveraged IPOs is the mood in the credit markets. Bankers say investors become wary of deals when it looks like the companies could have trouble refinancing their debt.
“It’s definitely picking up, but it will be gradual as we move into the second half,” says Frank Maturo, vice-chairman of equity capital markets for the Americas at UBS. “The jury is still out on leverage. It is becoming less of an issue partly because it appears interest rates are going to stay low for an extended period of time.”
* The article has been amended to accurately present the impact on KKR’s latest balance sheet from its First Data investment.