On Monday, the Peacock Group agreed to a £404 million (€595 million; $714 million) management buyout backed by investment bank Goldman Sachs, former chairman John Lovering and US hedge funds Och-Ziff Capital Management Group and Perry Capital.
A more common entry point for hedge funds in deals normally associated with private equity is to buy into distressed debt situations in the hope of converting that debt into equity as part of a restructuring.
A desire by Peacock’s incumbent management to maintain as much control as possible of the group is believed to have been an underlying reason for raising finance from hedge funds. “Some management teams, especially in MBOs, might be happier having hedge fund investors rather than private equity investors backing their acquisition, as hedge funds tend to invest with a shorter investment horizon and less involvement in the running of the company, whereas private equity firms can be extremely hands on,” says Jeremy Dickens, co-head of global capital markets at Weil, Gotshal & Manges.
Despite that, Dickens says that the short-term nature of hedge funds and the level of returns generated through financing instruments such as the pay-in-kind (PIK) notes Perry Capital and Och-Ziff used in the Peacock deal, makes competition with private equity players for buyout opportunities less likely.
According to Bank of America Business Capital: “PIK notes are fixed-income securities that pay interest in the form of additional bonds rather than cash…[and] are frequently used as a financing tool for leveraged buyouts because they enable the borrower to achieve higher leverage without paying cash interest on all of the funds raised.”
The interest – 16 percent in the case of Peacock – is rolled up to be repaid when the securities mature, generally after several years, rather than charged annually. “Private equity firms are often looking for IRRs (internal rates of return) between the mid 20s to high 20s over a period of three to five years, while a hedge fund may be quite happy to make 16 to 18 percent in one year,” adds Dickens.
Dickens also notes that there are only a handful of hedge funds that can compete with private equity firms for buyout opportunities and “are willing or able to invest in illiquid securities that they may have to hold for a few years”. He add: “To some degree, I view hedge fund capital and private equity capital as complementary, not as competitive.”
Tom Lamb, co-head of midmarket private equity investor Barclays Private Equity in London, agrees that competition from hedge funds will be limited and opportunistic in nature. “They’re not typically set up for long-term investment and management of unquoted companies,” he says. “It’s one thing to get involved in a quoted situation where the transaction is reasonably visible, but it’s harder for hedge funds to get involved in classic midmarket deals which are more based on relationships with the management teams and vendors. There’s a lot more to making money out of private equity than just bidding the highest price.”
Lamb adds that a number of intermediaries have spoken of being contacted by hedge funds recently wanting to look at midmarket deals, but few have responded to what they have seen. “I’ve heard the talk of hedge funds muscling in on private equity, but I’ve seen little evidence of it so far,” he concludes. “Out of the things that keep me awake at night, hedge funds aren’t in the top ten.”
It is still too early to tell whether or how the participation of hedge funds in the Peacock deal will affect the buyout market in the future, but there is little indication that private equity firms should be viewing them as competitors just yet.