Friday Letter Time to earn your money

Private equity’s long-term capital is getting creative in pursuit of value.  

Earlier this week, Guy Hands told an audience of private equity professionals at law firm SJ Berwin’s debate about disclosure that “private equity” was a misnomer and “long-term capital” a better description of his firm’s activities. The Terra Firma founder’s contention was that privacy was not the central ingredient of a successful deal, if indeed his deals were ever that “private”. His high-profile buyout of EMI is a case in point.

To Hands’ view patient shareholders, who back a closely aligned management team and can see the deal through the cycle, are more relevant. Transparency and disclosure are not the enemy of private equity. They are good for business: good for retaining employees at portfolio companies and attracting top executives to run them. They are also good for getting the deal on the table in the first place.

Hands also said investors and stakeholders appreciated bad news delivered swiftly more than pain withheld and dripped into the market – or worse: dropped as a nasty surprise, when it is too late to do anything but suffer.

And he is right about all of this. Long-term capitalists committed to openness are well-placed to profit from the current malaise afflicting the financial services industry. But they will also have to bring to bear considerable creativity to overcome the current funding drought.

Banks trying to finance deals in syndicates are now only crawling at the pace of the slowest credit committee and on the terms of the most conservative. And even then they are only contemplating smaller deals.

However, finance will be more freely available to those equity houses who are offering to help unblock the credit backlog.

For example: Duke Street Capital, an innovator in Europe’s credit markets –  it was the first buyout firm to launch a collateralised debt obligation fund –  is lining up two proprietary transactions with less conventional sources of funding. The UK-based firm is in negotiations to buy a £1 billion mortgage book from a US bank, in a deal which the bank will in turn finance. The firm is also in talks with an insurance company to buy an orphan asset, financed by the insurer, who instead of owning equity will enjoy a blended yield from a mix of debt tranches.

Both transactions are complex and call for a long-term view. They are deals that only long-term capital can tackle away from the distractions of quarterly public market reporting.

Get them right, communicate them well and no one will begrudge the industry its rich rewards.