Two big private equity deals are having trouble getting banks to lend them money. This trouble reveals the essential function of private equity firms -- the ability to convince banks that the fees they'll get for financing deals exceed the risk of loss if the borrowers can't pay back the money. In the past, the banks would sell portions of the loan to other banks and investors to limit their risk. But the appetite for those investments is disappearing.
Cerberus Capital Management and Kohlberg Kravis Roberts & Co. are both suffering this morning. The New York Times [registration] reports that Cerberus is not able to raise the $5 billion in debt it needs to finance its takeover of Chrysler. The snag is a result of investor unwillingness to accept the terms for $12 billion in loans and "does not jeopardize the deal."
Perhaps the deal is not in trouble, but if it does go through, the terms might make it less profitable for Cerberus. For now, the five banks, led by JP Morgan Chase & Co. (NYSE: JPM), plan to take on about $10 billion of the debt and try to sell it later -- Chrysler and Cerberus will carry the other $2 billion.
And KKR had a similar problem -- withdrawing the sale of $10.3 billion in loans to finance the buyout of British pharmacy chain, Alliance Boots. The eight banks involved will keep the debt on their books for now.
And therein lies the rub. Because when banks have to make loans and hold onto them, the banks incur the risk that the borrowers might not pay back the loan. Up until a few months ago, there were plenty of investors lining up to take that risk off the banks' books. Thus lending to private equity was a risk-free fee party.
And now investors are marking down the value of the players who used to drink from that fee fountain. Here's how much:
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JP Morgan down 17% to $44.16 from its May peak
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The Goldman Sachs Group (NYSE: GS) down 15% to $198.14 from its June peak
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Lehman Brothers Holdings (NYSE: LEH) down 23% to $65.66 from its February peak
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Blackstone Group (NYSE: BX) down 30% to $24.66 from its IPO-day peak.
Maybe a decade from now private equity will come back. But for now, the risk return calculus has changed. And a receding tide will reveal ugly damage to the hulls of these buyout tankers.
Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned in this post.
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Reader Comments (Page 1 of 1)
7-27-2007 @ 12:47PM
Art Hill said...
The markets have been wild and wooly and a retrenchment seems to be happening. There are too many unsold homes, defaulting mortgages, cancelling flippers and an overheated market. Its similar to the S&L crisis of 1987. I believe that it is healthy for the market, and will shake out a lot of the speculators and quick buck artists so that we can get back to normal. I have seen it a dozen times before and we;ll survive. Hang in.
Art Hill
7-27-2007 @ 12:49PM
Art Hill said...
The markets have been wild and wooly and a retrenchment seems to be happening. There are too many unsold homes, defaulting mortgages, cancelling flippers and an overheated market. Its similar to the S&L crisis of 1987. I believe that it is healthy for the market, and will shake out a lot of the speculators and quick buck artists so that we can get back to normal. I have seen it a dozen times before and we;ll survive. Hang in.
Art Hill