Private equity groups are now robbing Peter to pay Paul.
A report in the Financial Times highlights that the recent $6.6 billion acquisition of Stamps.com, a shipping business, by private equity group Thoma Bravo did not involve any financing arranged through banks. Instead, the debt financing will come from four private lenders, or private credit funds as they are known. One of those private credit funds is (drum roll please) Thoma Bravo’s own! The firm is lending itself the money to fund a leveraged takeover. What could possibly go wrong?!
This is the latest indication that the bubble in private equity and credit is extreme. The chart below shows the growth in private credit funds, vehicles that exist to seek out high returns through lending out their cash. Most of these private credit funds are branches of private equity groups and are increasingly using their cash to fund mergers and acquisitions for those very same private equity groups. Traditionally, if a private equity firm wanted to raid (err, buy) a company, it would arrange the financing via a syndicate of banks. Why not now? Could it be that banks are getting nervous of the credit risks involved in leveraged buyouts and other such deals in a record-setting year for mergers and acquisitions? Perhaps.
The FT article mentions that the increasing use of private credit funds to finance transactions is because of the certainty involved. In other words, private equity firms would rather not risk going to the banks for finance because it might be denied, or difficult to raise. Much easier to tap your own private credit fund or get your private equity / credit mates to provide the funds. Such inbreeding reeks of an environment whereby the private equity industry is living in the cloud cuckoo land of desperation to acquire. Get the deal done, doesn’t matter how, just get it done.
This quote from a lawyer involved in the private equity and credit industry sums up the house of cards that is here:
“It will be very interesting when the music stops, but given the experience of the last 18 months, I think people are either hoping it won’t or figure they keep deploying [cash] until it does so they don’t miss the upside.”
This is classic end-of-cycle, fear-of-missing-out, speculative behavior. When the music does stop, “interesting” will be a hell of an understatement. As private equity assets drop in value and the debt burden increases, defaults will rise, and it will be private credit funds that take the hit. A double whammy of deflation.