Buyout barons will find ways to douse fire sale

Springer Nature AG & Co KgaA

27/12/2024 06:00

(The author is a Reuters Breakingviews columnist.  The opinions
expressed are his own.)
    By Liam Proud
       LONDON, Dec 27 (Reuters Breakingviews) - If necessity is
the mother of invention, fans of financial engineering have a
treat in store from private equity titans in 2025.
The buyout industry has been sitting on portfolio companies for
longer than usual. The question is whether KKR  KKR.N , EQT
 EQTAB.ST , CVC Capital Partners  CVC.AS  and the rest can avoid
taking markdowns when offloading their giant backlog of assets.
Some innovative disposal tricks will help.
    Carlyle  CG.O , Stephen Schwarzman’s Blackstone  BX.N  and
others on average sold $430 billion of investments per year from
2022 to 2024, according to Preqin – well below 2021’s record
high of over $800 billion and lower even than the average for
the three years before the pandemic. That’s striking since
assets under management have almost doubled since 2019.
    From 2017 to 2021, the industry on average offloaded about
one-third of its holdings each year, according to Breakingviews
calculations using Preqin data. Since 2022, exits have run
at roughly half that rate, implying hundreds of billions’ worth
of “missing” disposals.
    The impetus to change that is clear. Buyout barons can’t
spend much more money until they realise some cash from old
stuff. That’s because investors like pension funds often rely on
profits from past funds to back newer ones. From 2022 to March
2024, the sector called up $136 billion more than it
distributed, Preqin data shows, meaning investors are overdue
some cash.
    And the shift towards ever larger deals in recent years
means that buyout barons must find new homes for some very big
companies. The average buyout size more than doubled between
2016 and the peak in 2021, according to Breakingviews
calculations using data gathered by Bain & Co. Large
disposals in 2025 may include Blackstone, Carlyle and Hellman &
Friedman’s potential $50 billion initial public offering of
healthcare group Medline, or Bain Capital and Cinven’s likely
sale of German drugmaker Stada, worth perhaps $11 billion.
    The question is whether the buyout barons’ portfolio
valuations will hold. So far, many players have avoided taking
big writedowns, even though stock markets stumbled after central
banks hiked rates. The paper worth of Blackstone’s corporate
private equity portfolio, for example, appreciated by 42% in
2021, when equities surged, but held strong in 2022 despite the
MSCI All Country World Index’s 20% fall.
    Industry proponents argue that such apparently rosy marks
reflect private companies’ superior growth rates, allowing them
to perform better than stocks. There may be some truth to that:
Blackstone said that its portfolio’s revenue rose 14% in the
fourth quarter of 2022. The danger, however, is that a deluge of
exits in 2025 puts pressure on paper marks.
    Luckily, there are tricks available to avoid a fire sale.
The most obvious is to find ways to only partially sell
companies by offloading stakes to new investors, rather than
listing the businesses or courting other buyout funds. That
avoids flooding the market.
    The most popular mechanism for such sales has been
continuation funds, special vehicles into which private equity
dealmakers can transfer specific assets. They’re usually spun as
a way for managers to keep trophy businesses, while allowing
some of the old investors to cash out by inviting in new
capital. BC Partners showed that they can also give problematic
businesses time to turn themselves around: it used a
continuation fund in 2021 for academic publisher Springer Nature
 SPGG.DE , which it finally listed in 2024 after it had paid
down debt.
    Buyout barons utilised continuation funds 49 times in the
first half of 2024, up 50% year-on-year, according to PitchBook.
That number will keep growing in 2025, especially with investors
like Mubadala Capital gearing up to buy stakes in private
equity-backed groups. Jefferies bankers estimated in mid-2024
that the total available capital to buy stakes in existing funds
or buyouts exceeded $250 billion.
    That huge sum will enable more novel transactions. One
example could be “strip” sales, where a buyout fund sells a
stake in a pool of different portfolio companies simultaneously.
Deals will also get bigger and more complex. EQT’s October $14.5
billion sale of private-school group Nord Anglia
Education proved the case for selling slices of very large
groups to multiple investors while keeping a stake.
    The Swedish firm’s boss, Christian Sinding, has proposed
taking things even further, by auctioning shares in its
portfolio companies to the private equity group’s clients. KKR
and Bain Capital have also considered this “private IPO”
idea, the Wall Street Journal reported. Such transactions are
now plausible because private equity groups have thousands of
institutional investors.
    The net result of all this innovation is that buyout barons
increasingly have ways to get money back to their investors
without risking a fire sale. Financial creativity will keep the
buyout party going in 2025.
    Follow @Breakingviews on X
    
    This is a Reuters Breakingviews prediction for 2025. To read
more of our predictions, click here.

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Graphic: Private equity exits have stagnated    https://reut.rs/3ZAYOqz
Graphic: Buyout barons are using more continuation funds    https://reut.rs/3DaVNWs
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 (Editing by Neil Unmack and Oliver Taslic)
 ((For previous columns by the author, Reuters customers can
click on  PROUD/ 
liam.proud@thomsonreuters.com))