EMI is the latest in a long line of businesses bought with junk-rated debt where the owners face pressure to surrender much or all of their investment to banks and other debt holders, according to private equity experts, reports the Guardian this week.
Terra Firma, the buyout owner behind the troubled music group home to Coldplay and Kylie Minogue, is asking fund investors to stump up an additional £105m to shore up this ill-fated business. Without this so-called "equity cure", buyout bosses will find themselves at the mercy of EMI's lending bank Citigroup — with whom they are already locked in bitter legal dispute.
Even if investors prove supportive, the cash injection is expected to buy EMI a grace period of about 12-months before tough decisions on restructuring the balance sheet have to be addressed.
High-profile woes for EMI come just weeks after another famous name, Manchester United, managed to refinance much of its debt through a £500m bond issue. Nigel Reynolds, a partner at PricewaterhouseCoopers and the author of a recent report on private equity-backed companies, said an increasing number of highly leveraged buyouts – typically deals done in 2006 and 2007 – will face debt repayment problems.
"With cheap, easy credit no longer available, the private equity model, based on high leverage and financial engineering, is no longer viable," said Reynolds. When deals were done in the boom years of 2006-2007, the funding agreements usually stipulated that the first major repayment – called a bullet repayment – would be made after five years. While private equity professionals were targeting a 3-5 year exit, that repayment was not a problem, but finding an exit is no longer straightforward, and hefty bullet repayments are looming.
"They now have to repay or ramp up their debt", said Reynolds, "and that depends on the banking market and on the success of IPOs [stock exchange flotations]. A lot of companies need to refinance, and that's why there is now a pipeline of possible IPOs: [companies] need to repay debt before it comes due." But bringing debt-laden companies to the stock market, he warned, will not be straightforward: "No-one wants to put up money to repay debt."
Fashion chain New Look – controlled by Apax Partners and Permira – could run into just such problems. The retailer, which plans a £1.7bn float, intends to raise £650m to pay down some of its £1bn debt. But New Look will still have a big debt – compared with none at rival fashion business Next.
PwC interviewed 12 private equity backed companies which had been bought out at the height of the boom in highly-leveraged deals. Most of them, it reports, "say the burden of the debt they are operating under has seriously restricted their ability to carry out their strategy" – but debt restructuring is not a realistic option. The companies said they had to grow their bottom line, even in the recession – because if they didn't they would breach their banking covenants.
One senior figure at a major buyout firm, who asked not to be named, echoed Reynolds findings suggesting many private equity owners would still have to hand over some or all of their investments eventually. Three private equity owners of gambling group Gala Coral – Permira, Candover and Cinven – are expected to formally lose control of the business next week, surrendering ownership to the companies mezzanine debt holders, including Apollo Management and Cerberus.
Other debt-financed buyouts to have seen their private equity-owners lose out include Countrywide, Britain's biggest residential estate agent, and house builder Crest Nicholson. Part of the reason why debt financing for private equity deals became so plentiful was because many banks found they could package up and sell on buyout loans within poorly understood financial packages known as collateralised debt obligations (CDOs). According to Bank of England figures about a third of loans used to finance private equity style deals in Europe are ultimately held though such packages. Optimists in the private equity world point to a substantial rally in the price of LBO debt. According to credit data firm Markit, senior five-year loans at Gala Coral, Manchester United, Formula One, New Look, and Alliance Boots was variously trading in the secondary market at between 50p and 65p in the pound a year ago. Today confidence has returned and this debt is trading between 92p and 100.5p.