Friday Letter Healing the pain

Restructurings are on the rise – but debt-for-equity swaps aren’t the only means to give private equity portfolio companies a new lease of life.  

The corporate world is bracing itself for a massive round of restructuring as big chunks of buyout debt from the credit boom are due to mature between 2011 and 2013.

On both sides of the Atlantic, there have already been many sponsors left empty-handed as lenders walk away with the keys. The most recent example of this is Paris-based printing group CPI.  Purchased four years ago for €450 million by CVC Capital Partners and Cognetas, CPI was this week the subject of a €297 million debt-for-equity swap, which left an RBS-led banking syndicate in control and the private equity firms out in the cold. Mike Taylor, UK chief executive of CPI Group, told UK trade paper Print Week that freed of the leverage CPI has carried since the buyout, the company had been given “a new lease of life”.

Such restructurings are increasingly common, as one market source explains, because if debt holders exercise their rights to take over a company – especially when its value has sunk below its debt levels – the lenders make sure they get all the upside and protect their interests. The notion that banks don’t want to own companies is long gone, they added, particularly now that many ex-private equity professionals are offering their portfolio management services to the banks.

However, it’s important to note that these types of restructurings are not the only ones happening, and not all lenders are prepared to take ownership of companies.  Also common is what’s been (perhaps unfairly) dubbed the “Band-Aid” approach – that is, lenders extend their terms to allow a company more breathing room. The situation at Apax Partners’ Hit Entertainment, as revealed this week by PEO, is likely to produce such an outcome: according to sources, Hit didn’t really need an equity injection, but covenant resets.

There are many potential issues that can arise from this approach, the most important being that ongoing interest payments on an outsized debt burden could hamper a company’s growth prospects indefinitely. But equally, in many cases a Band-Aid can be just the treatment a portfolio company needs – giving it time to heal, and to implement revised plans for growth.

For the sponsor, of course, this will always be the better road, as it gives them the chance to preserve and possibly even enhance the value of their equity investment.  What’s crucial for the companies – and for the reputation of the private equity industry – is that financial sponsors make certain their restructuring plans don’t just prolong the status quo with all its pain, but deliver a fully developed recovery programme to bring the struggling company back to life.