Private Equity Investing in the Current Credit
Environment
January 2009
Vik Sawhney
The Blackstone Group
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Private Equity Investing in the Current
Credit Environment
Introduction
f The unprecedented credit-related turmoil that began in the summer of 2007 continues:
Collapse in residential mortgage market
Unwinding of structured credit and hedge fund forced selling
Evaporation of liquidity and dramatic repricing of risk
Bank consolidation
Recession…
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Private Equity Investing in the Current
Credit Environment
Introduction (Cont’d)
f How will the current credit environment impact private equity in the near term?
Continued dearth of large, "plain vanilla" LBOs
Once in a lifetime debt purchasing opportunities
Lower leverage, lower TEV deals
Structured deals – who needs new debt?
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Historical Leveraged Loan Volume
Private Equity Investing in the Current
Credit Environment
($ in billions)
$900
$841
$600
$861
$750
$500
Market Size
$400
$426
$366
$450
$300
$408
$307
$300
$223
$241
$200
$188
$150
$0
$5 $2
$16
1993
1994
$5
$23
1995
$34
$8
$53
$14
1996
$88
$126
$145
$141
$141
$100
$95
$118
$25
$45
$55
$50
$32
1997
1998
1999
2000
2001
Institutional Loan Market Size
New Institutional Loan Volume
$617
$600
$64
$0
2002
2003
2004
2005
2006
2007
2008
(1)
New Institutional Loan Volume
________________________________________________
Note: Includes $US-denominated non-investment grade fully drawn institutional term loans (TLbs, TLcs, TLds delayed-draw, and other tranches held by institutional investors).
Source: Credit Suisse, LPC.
(1)
As of 9/30/2008.
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Growth of CLO Market Fueled Record New Issuance for
Leveraged Loans
Private Equity Investing in the Current
Credit Environment
Demand from CLO’s and hedge funds, which accounted for over 80% of the demand for new leveraged
loans, has disappeared.
Annual CLO Issuance(1)
Ownership of Leveraged Loans Over Time(2)
($ in billions)
$120
(by Investor Type)
$100
$97.0
Nearly 10 Fold Increase in
Annual New Issuance Over Last
Five Years
Investor Type
1998
2007
CLOs / CDOs
10.4%
59.0%
3.8%
23.0%
14.2%
82.0%
Prime Loan Funds
36.3%
10.0%
Money Managers & Foreign Banks
27.7%
–
Insurance / Financials
21.8%
8.0%
100.0%
100.0%
Distressed / Hedge Funds
$88.9
Total
$80
$60
$52.6
Total
$40
$25.5
$20
$9.1
$12.1
$16.2
$0
2001
2002
2003
2004
2005
2006
2007
________________________________________________
(1)
Source: Goldman Sachs.
(2)
Source: JP Morgan.
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Private Equity Investing in the Current
Credit Environment
Leveraged Loan Spreads Trading at a 15-Year Highs
Leveraged loans trading at highest spreads in history.
1200
1100
12/31/08:
L+1,257 bps
15-Year Average = 339 bps
1000
900
800
700
600
500
400
300
200
Ju
l -9
2
Ja
n93
Au
g93
Fe
b94
Se
p94
Ma
r-9
5
Oc
t-9
5
Ma
y-9
6
No
v-9
6
Ju
n97
De
c-9
7
Ju
l -9
8
Ja
n99
Au
g99
Ma
r-0
0
Se
p00
Ap
r-0
1
Oc
t-0
1
Ma
y-0
2
No
v-0
2
Ju
n03
De
c-0
3
Ju
l -0
4
Fe
b05
Au
g05
Ma
r-0
6
Se
p06
Ap
r-0
7
Oc
t-0
7
Ma
y-0
8
De
c-0
8
100
________________________________________________
Source: Credit Suisse Leveraged Loan Index.
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Private Equity Investing in the Current
Credit Environment
Historical High-Yield Volume
($ in billions)
$1,000
$853
$800
$848
$160
$136 $135
$652 $668
$116 $113
$467
$77
$400
$181 $206
$200
$242 $214
$247
$363
$283
$120
$89
$101
$80
$82
$308
$67
$72
$205 $205
$136
$81
$33 $30 $32
$57
$41
$28 $2
$35
$30
$32
$24 $26 $28
$17
$15
$15
$43 $45
$47
New Issue Volume
$580
$600
Market Size
$881
$737
$150
$133
$0
$200
$932
$878 $876 $888
$45
$40
$48
$0
1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
High Yield Market Size
(1)
New Issue Volume
________________________________________________
Note: Includes non-investment grade $US-denominated straight corporate debt. Floating-rate and convertible bonds and preferred stock are not included.
(1)
YTD as of November 28, 2008.
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Private Equity Investing in the Current
Credit Environment
Historical High-Yield Prices
120%
Percent of Par
104%
88%
72%
56%
40%
Jan-86
May-88
Sep-90
Dec-92
Apr-95
Jul-97
Nov-99
Feb-02
Jun-04
Sep-06
Jan-09
________________________________________________
Source: Credit Suisse, as of 1/15/09.
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Private Equity Investing in the Current
Credit Environment
Historical High-Yield Spreads
2,000
1,600
BB Spread: T + 982bps
B Spread: T + 1,520bps
HY Index Spread: T + 1,581bps
bps
1,200
800
400
0
Jan-86
May-88
Sep-90
Dec-92
Apr-95
Jul-97
BB Spread
B Spread
Nov-99
Feb-02
Jun-04
Sep-06
Jan-09
HY Spread
________________________________________________
Source: Credit Suisse, as of 1/15/09.
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Private Equity Investing in the Current
Credit Environment
Potential distressed
supply of over $1
trillion compared to
$125 billion in 2002,
which was the
previous peak default
level.
Potential Distressed Supply
U.S. & European
($ in billions)
Total Debt Issued
2005–2008 YTD # Issues
Potential Distressed
Par Amount
Default Rate Ranges
Investment Grade Loans
$4,554.8
5,290
2.0%
–
4.0%
$91.1
$182.2
Investment Grade Bonds
11,671.8
44,932
2.0%
–
4.0%
233.4
466.9
3,644.8
7,195
7.0%
–
10.0%
255.1
364.5
566.2
$20,437.6
1,508
58,925
7.0%
–
10.0%
39.6
$619.3
56.6
$1,070.2
Leveraged Loans
High Yield Debt
Total
________________________________________________
(1)
Source: Houlihan Lokey.
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Private Equity Investing in the Current
Credit Environment
Private Equity Group
Debt Investment Track Record
The Private Equity Group has proven experience investing in debt securities. Examples include:
Transaction
Blackstone Investment
Investment Overview
Adelphia
BCP III & BCOM
° Worked in partnership with Blackstone’s Restructuring Advisory Group to make investment in
distressed public debt
° Understood and focused on industry-wide consolidation that brought financial distress to smaller
companies
Charter
BCP III & BCOM
° Worked in partnership with Blackstone’s Restructuring Advisory Group to make investment in
distressed public debt
° At investment, BCP/BCOM correctly concluded that the market had exaggerated near term
liquidity pressures
DeBartolo
BCP I
° Investment in senior debt of diversified commercial real estate company
° Held debt over longer period as BCP believed in solvency
Kabel BW
BCP III & BCOM
° Investment in subordinated debt of German cable operator
° Interpreted macroeconomic shifts as signaling a revitalization in German cable
Kabelnetz
BCP III & BCOM
° Investment in debt securities of German cable operator
Primacom
BCP III & BCOM
° Investment in subordinated debt of German cable operator in partnership with another leading
private equity firm
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Private Equity Investing in the Current
Credit Environment
Illustrative Returns on Potential Debt Investment
Opportunities
Company A YTM Sensitivity
Company A
Debt Purchase Price
Industry
Total Leverage
Security
Leverage Ahead
Trading Price
Current Yield / YTM
MOIC to Maturity
Food and Beverage
7.0x Debt/Leverage
Second Lien TL
5.7x Debt / EBITDA
50.000
30
Exit Price
40
50
40
34%
24%
17%
70
38%
29%
22%
100
41%
32%
26%
20% / 26%
3.3x
Company B
Company B YTM Sensitivity
Debt Purchase Price
Industry
Financial Technology
Total Leverage
Security
6.0x Debt / EBITDA
Senior Sub Notes
Leverage Ahead
Trading Price
5.0x Debt / EBITDA
60.000
Current Yield / YTM
MOIC to Maturity
30
Exit Price
40
50
40
36%
26%
19%
70
39%
30%
23%
100
42%
33%
27%
17% / 22%
2.9x
________________________________________________
Note: These statistics are for illustrative purposes only and are not meant to be indicative of any fund performance or any potential transaction.
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Private Equity Investing in the Current
Credit Environment
High Leverage Not Necessary for Outsized Returns
Pre-Credit Crunch
Current Environment
10.0x
6.5x
Total Debt / EBITDA
7.0x
3.0x
Average Cost of Debt
8.5%
10.1%
8.0x
8.0x
Investment Safety
% Equity Capitalization
Year 1 Interest Coverage
30.0%
1.9x
53.8%
3.6x
Assumed Returns
Gross IRR
Gross MOIC
18.9%
2.4x
29.5%
3.6x
Assumed / Actual Transaction Setup
TEV / EBITDA
Exit Multiple
________________________________________________
Note: These statistics are for illustrative purposes only and are not meant to be indicative of any fund performance or any potential transaction.
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Private Equity Investing in the Current
Credit Environment
Illustrative IRR Bridge on Unlevered Equity Investment
IRR Bridge
35.0%
30.0%
3.7%
25.0%
5.1%
20.0%
IRR
5.7%
30.6%
15.0%
10.0%
16.1%
5.0%
0.0%
Unlevered Cash on
Cash Return
Multiple Expansion
(+3.0x)
EBITDA Growth
(+7.0% )
Recap to 3.5x Net
Leverage in Yr. 3
Potential IRR
________________________________________________
Note: Unlevered cash on cash return assumes setup multiple of 5.0x and FCF accumulated on the balance sheet come from 7.0% EBITDA growth.
Note: These statistics are for illustrative purposes only and are not meant to be indicative of any fund performance or any potential transaction.
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Private Equity Investing in the Current
Credit Environment
U.S. Debt Maturity Schedules
Record new issuance will lead to substantial debt maturities which may not be refinancible.
U.S. Loan and High Yield Bond Maturities(1)(2)
($ in billions)
$400
$366
$350
$328
Maturity Amount
$300
$250
$228
$220
$185
$200
$130
$150
$100
$92
$50
$0
2009
2010
2011
2012
Term Loans
Revolvers
2013
2014
2015
High Yield Bonds
________________________________________________
(1)
Source: Deutsche Bank.
(2)
Revolver Amounts Include Unfunded Portion.
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Private Equity Investing in the Current
Credit Environment
Innovative Structures Will be Key
f Structure within Change of Control (COC) provisions
Existing leverage is long dated, cheap, covenant light
Can invest up to 49% and create a new-LBO
f De-leverage an existing levered credit
Again, take advantage of existing leverage benefits
Existing lender base passes a waiver or an amendment
Achieved through below-market purchase, amplifying
de-leveraging affect and setting up deal at lower multiple
f Assumption of leverage with asset sales or spins
Assets are sold or spun from the company accompanied with debt
Accompanying leverage has similar existing benefits
Original company has less debt
Sponsors inject fresh equity that is not “out of the money” into the new company
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Private Equity Investing in the Current
Credit Environment
Disclaimer
Prospective investors should be aware that an investment in a private equity fund (the “Partnership”) involves a high degree of risk. The following is a summary of only certain considerations and is
qualified in its entirety by the more detailed “Risk Factors and Potential Conflicts of Interest” set forth in the Private Placement Memorandum. Capitalized terms used below have the meanings set forth in
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such as rising interest rates, downturns in the economy, or deterioration in the financial condition of such assets or industry. In the event an asset cannot generate adequate cash flow to meet its debt service, the
Partnership will suffer a partial or total loss of capital invested in the asset, which would adversely affect the returns of the Partnership.
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unless they are subsequently registered under applicable securities laws or an exemption from registration is available. There is no public market for Interests in the Partnership and one is not expected to
develop. A Limited Partner will generally not be permitted to assign, sell, exchange, or transfer its Interest in the Partnership without the consent of the General Partner (which consent may not be unreasonably
withheld).
Failure to Make Payments. If a Limited Partner fails to pay when due installments of its Commitment or its portion of Management Fees, Organizational Expenses or other obligations to the Partnership, such
Limited Partner will be subject to various remedies including, without limitation, preclusion from further investment in the Partnership, reductions in its capital or loan account balance, and a forced sale of its
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Private Equity Investing in the Current
Credit Environment
Disclaimer
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