Where's the Flexibility?
November 15, 2010
Last Friday, at the Yale School of Management's Private Equity conference, I had the chance to moderate a panel on alternative exit strategies and as expected the conversation gravitated toward dividend recaps. Considering there has been $40-plus billion worth of dividend-related debt issued so far this year, recaps may be considered "alternative" in the same way a band like Pearl Jam qualifies as alt rock.
There will always be a debate whether or not dividend recaps are fundamentally good or bad. And there are enough examples to prove out each side of the argument. Randy Schwimmer, in a recent blog item, poignantly identifies that recap-related debt actually performs better than traditional LBO credit.
My question, though, is why haven't recaps fundamentally changed the way the asset class thinks about exits? As the recent rash of recaps seems to highlight, it allows sponsors the opportunity to return capital to investors, while easing the pressure to secure that ultimate realization. GPs can be just as opportunistic, if not more so when it comes to timing the market.
Look at HCA, which the Wall Street Journal reported last week had returned nearly all of the consortium's equity commitment through multiple recaps. The company already filed its S-1, so we all know how that story is going to end.
I remember this book from the early 80s. It was one of those "choose your own adventure" novels in which the reader played a hockey coach and was faced with a handful of coaching decisions. Private equity needs something like that, because I want to know what would happen if the sponsors just held onto HCA and spent the next decade collecting dividends.
We've seen a few instances in which sponsors have done just that. Berkshire Partners' 22-year investment in Advanced Drainage Systems would qualify. The firm sold the company earlier this year to American Securities, which itself, is operating out of a fund with a 25-year fund life. But those are the exceptions.
Regarding HCA, I imagine one argument is that an IPO would allow the investors to get out ahead of uncertainty over healthcare reform. Of course that argument goes against HCA's reasons for going private in the first place.
It may be an IRR killer, but why not amass a portfolio of blue chip assets that over time will generate a better cash-on-cash performance?
Coming out of the credit crisis, I expected more funds to seek that kind of flexibility. The trend, though, appears to be moving in the opposite direction. I spoke with one GP at the conference currently raising a vehicle with an abbreviated investment window and fund life. They said that the structure was gaining traction with limiteds, who only want more liquidity following the turmoil of the past few years.
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We've seen a few instances in which sponsors have done just that. Berkshire Partners' 22-year investment in Advanced Drainage Systems would qualify. The firm sold the company earlier this year to American Securities, which itself, is operating out of a fund with a 25-year fund life. But those are the exceptions.android tablet pc
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Posted by: Bill B B | September 30, 2011 7:48 PM
"why not amass a portfolio of blue chip assets that over time will generate a better cash-on-cash performance"? 1) it is not the business of PE groups with limited life funds and who have a fidicuary responsibility of returning capital back to investors and then some. 2) raising new funds, a critical part of the PE discipline, is about being vetted for prior fund performance. 2) PE groups rarely exit a company completely, but for both legal and economic reasons hold on to minority positions over time (tends to give IPO more credibility). The fact that this process has worked over up and down cycles for the past 40 or some years suggests it does a pretty good job of meeting the market test.
Posted by: David H | November 15, 2010 8:34 PM
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