By Mike Spector | The Wall Street Journal
It all was going so well. For the first 5½ months of the year, private-equity firms took advantage of soaring markets and eager investors to raise about $35 billion by selling stakes in their companies, not to mention billions of dollars more through initial public offerings.
The rush for cash prompted some buyout executives and bankers to view 2013 as the year of the exit, a moment to reap what they sowed, including on some highly indebted, controversial deals just before the eruption of the financial crisis. Leon Black, Apollo Global Management LLC co-founder, in April called the market's receptiveness to such sell-downs "biblical."
Then the markets turned. Stock and bond prices fell amid fears of an end to the Federal Reserve's stimulus, and the resulting market turbulence this month threatens to disrupt the sales planned by private-equity firms and possibly put the brakes on a blistering pace of big paydays for their top executives and investors.
The public offering of HD Supply Holdings Inc., a construction-materials supplier, priced Wednesday at $18 a share, far below the range of $22 to $25 the company previously expected. Private-equity-owned information-technology company CDW Corp. on Wednesday priced its IPO at $17, also well below the company's previously expected range of $20 to $23. The private-equity owners have decided not to sell their stakes in either deal.
At the same time, Five Below Inc., a retailer owned by private-equity firm Advent International Corp. and others, moved ahead with a share sale this week after a delay last week that cited market conditions.
"The exits will be more difficult because the stock market is seemingly pretty volatile," saidChristina Padgett, a Moody's Investors Service analyst. Buyout firms "have the ability to be patient, although the limitation to that is that they've been holding on to these investments from a historical perspective longer than is typical. They may feel more pressure to return capital" to investors, she said.
Others say the markets aren't spooking private-equity firms. The exits are "still really zinging along," said Michael Ryan, a lawyer at Cleary Gottlieb Steen & Hamilton LLP who specializes inprivate equity.
Such investment exits are crucial for private-equity firms because they create deal profits for the firms' executives and the pension funds, universities and wealthy individuals that give them money to invest. When buyout firms successfully cash-in on deals years later, it helps them raise a new round of money from investors—a virtuous cycle that can be damaged if selling down an investment doesn't deliver the desired profits.
Private-equity firms and some other investors so far this year have sold more than $35 billion of U.S.-listed shares in already-public companies they own, on pace to eclipse the record of roughly $37 billion sold last year, according to Dealogic, a data provider that has tracked the transactions since 1995.
Meanwhile, private-equity-owned companies have raised more than $10 billion in U.S.-listed deals going public so far this year, on track to exceed the roughly $13 billion in IPOs in 2012, though likely to be short of the record $27 billion in 2011.
Despite the recent market volatility, there is "the potential for a trifecta of open windows, and all three windows being open means you're going to see a lot of activity," said Jim Coulter, co-founder of private-equity firm TPG, referring to share sales, IPOs, and company sales. He also pointed to so-called dividend recapitalizations, where companies pay investors with borrowed money.
Many of the deals being sold off involve companies bought in so-called leveraged buyouts during the cheap-debt boom preceding the financial crisis. And they could make money for their owners even with a few bad apples.
Among 29 of the largest takeovers by private-equity firms completed between 2005 and 2008, theequity investments that buyout specialists made in the deals increased 21% to roughly $142 billion as of the end of 2012, according to an analysis for The Wall Street Journal by Hamilton Lane, a Philadelphia firm that manages and advises on more than $158 billion in private-equityinvestments. By comparison, the Standard & Poor's 500-stock index rose about 14% between the end of 2005 and 2012.
The upshot is the buyout firms gained about $25 billion on their equity investments alone across all the deals, even when including the record buyout of Texas power giant TXU Corp. that is likely headed for bankruptcy court. Private-equity firms typically finance takeovers with a small amount of their own money and a larger slug of borrowed funds, which can amplify their returns. The Hamilton Lane analysis surveyed 29 buyouts worth more than $5 billion, including debt, and the gains reflect both paper and realized profits for the firms and their investors.
"During the global financial crisis and immediately afterward, there were predictions that this group of deals was going to be the end of the private-equity industry," said Hartley Rogers, Hamilton Lane's chairman. The gains were "not heroic, but far from being a major disaster."
Take Realogy Holdings Corp., a real-estate agent owner purchased by Apollo in 2007. The deal looked disastrous when the housing market crashed and the company's revenue plunged. But Realogy reworked debts, cut more than 4,000 jobs and is now eight months into trading on the New York Stock Exchange. Its shares are up around 79% since their October public debut, though they are down more than 11% since their peak May 21.
Employees can suffer when buyout firms cut jobs and other expenses, and creditors sometimes take losses when debts get reworked, even when they agree to such moves. Bonds can decrease in value when a company struggles, forcing early investors to renegotiate terms or ride out the storm in the hopes prices return to their original full-value level.
"To the extent you were one of the [full-price] buyers on day one, you had quite a wild ride, which is not what you're supposed to have," said Gautam Khanna, a portfolio manager at Cutwater Asset Management, a firm that manages $29 billion and makes debt investments. But government stimulus made credit markets inviting, allowing companies to refinance debts, he said. "If that had not been the case, arguably many of these LBOs might have had bad outcomes."
Not all deals are successes. Apollo and other buyout specialists in 2006 purchased Linens 'n Things Inc. for $1.3 billion, using $260 million of cash and adding more than $1 billion of debt to the struggling retailer. Linens filed for bankruptcy protection in May 2008 and eventually liquidated, eliminating some 17,000 jobs. While Apollo lost all it had invested in the retailer, the money amounted to 2% of its most-recent buyout fund at the time, and the fund overall ended up delivering profits.
Others have thrived. Blackstone Group LP in April took SeaWorld Entertainment Inc. public, tripling its roughly $1 billion investment made in December 2009 when including money returned to investors and the value of the firm's remaining ownership stake. KKR & Co. in April sold shares ofDollar General Corp. for $812 million, 5.6 times its original investment of that stake in July 2007.
Matt Jarzemsky contributed to this article.
Write to Mike Spector at mike.spector@wsj.com and Telis Demos at telis.demos@wsj.com
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