The private equity industry should in theory be braced for a massive round of restructuring at companies it has backed. Buyout debt from the credit boom is due to mature in the years ahead, much of it from 2011 to 2013. As a result, it would be no surprise to see restructuring advisers rubbing their hands with anticipation.
Indeed, we have already seen a few significant deals of this nature completed in Europe: roofing business Monier and yacht maker Ferretti among them. A recent addition to the list was Paris-based printing business CPI Group.
In the case of CPI, the two financial sponsors – CVC Capital Partners and Cognetas – were removed from the company's capital structure. The lenders, led by RBS, injected €30 million into the business and slashed its debt to €123 million from €420 million. CVC and Cognetas (then known as Electra Partners) acquired CPI just over four years ago for €450 million.
To date, however, wholesale restructurings have in many cases been usurped by an approach variously referred to as “sticking plaster”, “band-aid” or “amend and extend”, whereby covenants are reset, a fee is paid and the debt re-priced. Apax Partners' Hit Entertainment, an owner and distributer of children's brands like Thomas the Tank Engine and Bob the Builder, looks likely to be the recipient of something along these lines.
One restructuring specialist says these “sticking plasters” arise from a “perverse alignment” of sponsors and lenders.
Normally, when a company enters into financial stress or distress, the lenders seek a solution that allows the business to recover through reducing its balance sheet liabilities. This might involve an injection of new liquidity and perhaps the conversion of some debt into equity. The sponsor's reluctance to give away equity normally means tension in the process.
But lenders have not been clamouring to go down this avenue. CLO funds have not been keen to convert debt to equity – they are often not set up structurally to do this – and the banks have been unwilling to write down their loans. Sponsors meanwhile, under the now more watchful gaze of limited partners, are reluctant to throw good money after bad. Both sides of the table have therefore been incentivised to maintain the status quo.
“Nobody wants to do anything to change the capital structure of a business … least of all if it can afford to pay interest on its debts at the moment,” says Simon Davies, a managing director within Blackstone Group's corporate advisory arm, on the sidelines of the Debtwire European Forum in London.
Is there anything wrong with this “perverse alignment”? After all, if you can service the interest bill and all parties buy into it, “who's going to grouse?” as one adviser asks.
There are, however, some potential issues. If the equity remains underwater, then management incentives based on that equity become less effective or perhaps ineffective. And a heavily indebted company may also encounter trade credit issues: it may not be considered a solid counterparty.
Furthermore, ongoing interest payments on an outsized debt burden will almost certainly hamper a company's growth prospects. Cash – which in these situations is likely to be scarce – will be directed away from investment in growth and towards debt repayments.
Reading comments from CPI Group's UK chief Mike Taylor on its recent process brings into focus just how reinvigorating a restructuring can be.
The transaction would “dramatically strengthen” the group's position, freeing it of the high debt level of the past five years and giving it “a new lease of life”, he told UK trade paper PrintWeek. He added: “The net effect at group level is that the balance sheet is dramatically improved and of course the group's profit and loss will be significantly improved by the reduced debt burden and the reduced interest charges on that debt.”
But the devil is in the detail of each individual case. It is hoped that where sticking plasters have been applied, companies have bought enough time to be rescued ultimately by rebounding trading conditions.
Consider also that if all stressed and distressed businesses were the subject of debt-for-equity swaps rather than sticking plasters, a bigger problem may arise. Write-downs on what is estimated to be as much as $1 trillion in outstanding buyout debt (there is no concrete data) could well trigger further structural issues within the banks. Viewed in this light, applying plasters may be no bad thing.