Private equity’s growing leverage hack

In today’s newsletter: 

Net asset value financing: leverage on leverage

For the past decade, private equity has been a relatively simple business: buy a company using cheap debt and long-term capital from investors such as pension funds, hold it for a few years, then sell or list it for a profit. 

Higher interest rates are challenging this model, with some firms turning to evermore complex financial engineering, complicating the equation behind the buyout game, DD’s Will Louch and Antoine Gara and the Financial Times’s Chris Flood report.

One way firms are doing this is by adding a layer of leverage to their portfolios by using a relatively novel technique called net asset value financing. The increasingly popular loans are being used to unearth new cash as the private equity circle of life has slowed.

Private equity firms are finding it difficult to cash out of the companies they own, but are being pressured by their investors to return profits before they commit to new funds. 

It’s a tough proposition while public markets remain largely shut to new listings and buyers wait for bargains. 

Sales to corporate buyers and other private equity are on course to fall to their lowest level in a decade, according to PitchBook data.

Like many things in private equity, the solution to this quagmire involves more debt. 

To take out NAV loans, private equity firms borrow against portfolios of assets, adding an extra layer of debt to their already leveraged corporate buyout investments. This collateralises risk across a number of assets, rather than limiting it to individual companies. In a worst-case scenario, borrowing against a fund could see it wiped out.

Lenders like the diversification of these loans and — importantly — that they’re getting paid handsomely to lend as interest rates surge. Recent NAV loans seen by the FT carry spreads of at least 7 percentage points above benchmark rates, which have soared, and made borrowing costs greater than 10 per cent and as high as 30 per cent. 

The once-novel tactic is becoming mainstream. Blue-chip firms including Vista Equity Partners and Carlyle Group have each borrowed more than $1bn from specialist providers to pay out their backers over the past 12 months or so. (Vista has also sold more than $14bn in assets since late 2021 as it raises a new buyout fund)

Hg Capital, Europe’s largest software investor, has raised at least £500mn via NAV loans to help finance payouts, according to people close to the firm.

Joana Rocha Scaff, head of European private equity at Neuberger Berman said that the practice “can have some useful benefits” but also adds “incremental financial risk”. 

Not only are many of these loans floating rate, meaning their costs have increased, they also come with payment-in-kind features that mean debts can build over time. This could hurt investors in the long run. 

GQG makes another big bet on India

Baba Ramdev is a televangelist yoga guru with more than 9mn followers on YouTube. But US investment group GQG Partners is interested in his other endeavour — his multibillion-dollar consumer goods empire.

The Florida-based firm run by Rajiv Jain has purchased a 6 per cent stake worth an estimated $290mn in Patanjali Foods, a listed company of Patanjali Ayurved, the consumer group co-founded by the yogi tycoon.

DD readers may remember Jain, whose GQG manages some $92bn in assets, as the first big investor to bet on Adani Group after it was hit with a short seller attack from Hindenburg Research in January.

Before ploughing billions into Gautam Adani’s companies, the star trader (who discussed his due diligence process behind the Adani investment with the FT in April) already had significant exposure to India.

The deal reveals a deepening business relationship in India between GQG and US investment bank Jefferies Financial Group, which introduced GQG to Adani and also acted as brokers for Patanjali Foods in the sale along with IIFL Securities. 

It will also help Patanjali Foods propel the growth of its unlisted parent company, which has taken on multinationals including Hindustan Unilever and Colgate in its home country.

Ramdev, who has courted controversies such as claiming yoga can defeat Covid-19, has also used fame to generate sales.

“Do you want to be a millionaire? I will give you the mantra to become a millionaire,” Ramdev told his millions of followers on live television in 2021, before instructing them to buy shares in what would eventually become Patanjali Foods.

Can Evergrande climb out from under a $340bn debt pile?

It has been nearly two years since Evergrande shocked financial markets by defaulting on its debts.

But the Chinese property developer had kept the scale of its financial woes under wraps, perhaps in the hope of being able to report better results in a more favourable environment.

That hasn’t materialised, with the property sector in China still paralysed. So on Tuesday, Evergrande revealed losses of $81bn over a two-year period. The company’s total liabilities, which measured about $300bn at the time of its failure, were up to $340bn by the end of 2022.

As bad as that seems, there’s a chance things are even worse in reality. Evergrande’s auditor Prism Hong Kong — which replaced PwC when it resigned in January — said there was “material uncertainty” over the company’s ability to operate.

The next step in the restructuring process will be for Evergrande to convince at least three-quarters of each group of creditors to approve a plan to overhaul its debt.

It won’t be an easy sell, Lex notes. Creditors are pushing for the bankruptcy of a real estate unit of Evergrande in the city of Xian and the group faces more than 1,300 lawsuits with total claims of $45bn, many of which are from disgruntled foreign investors who would prefer a quick sale of its assets to lengthy restructuring talks.

The risk of contagion is ever-present as Chinese high-yield dollar bonds have declined to the brink of distress. 

A winding-up petition scheduled for the end of this month in Hong Kong could potentially result in such a court-ordered liquidation.

The upcoming court dates add to the pressure on Hui Ka Yan, the group’s billionaire chair and once the richest man in China, to part with his personal assets to help satisfy Evergrande’s creditors. 

At least Hui, the poker-playing tycoon revealed by the FT as the owner of London’s most expensive home, has a 45-room mansion overlooking Hyde Park to part with if push comes to shove.

Job moves 

• Apollo has appointed Greger Hamilton, co-founder of European Resolution Capital Partners and a Goldman Sachs alum, as an operating executive and senior adviser focused on the Nordic region. 

• Credit Suisse has told London investment bankers that it will cut 80 roles by the end of July, per Financial News.

• French luxury group Kering has announced a big management overhaul including the departure of Gucci chief executive Marco Bizzarri in September. 

• Italy’s Ermenegildo Zegna Group has poached LVMH executive Lelio Gavazza to run its recently acquired Tom Ford fashion business.

• PJT Partners has hired former Centerview Partners and UBS banker Roland Phillips for consumer dealmaking.

Smart reads

Friends to frenemies A political rift between Saudi Arabia’s crown prince and his former mentor, the president of the United Arab Emirates, reflects the countries’ increasing rivalry for money and power in the Gulf, The Wall Street Journal reports.

Ants on the march An army of South Korean retail traders known as “ants” are taking on hedge funds, having fuelled a nine-fold rise in the shares of a battery materials producer, the FT reports.

‘The Vanguard Way’ The US fund giant has tried to replicate its business model and corporate culture across the Atlantic. But Europeans aren’t buying it, Bloomberg reports.

News round-up

Morgan Stanley’s profits drop as trading slowdown bites (FT)

Odey to reopen James Hanbury fund as emergency transfer nears (FT)

Bank of America’s trading arm helps profits beat expectations (FT)

Adnoc is said to boost Covestro takeover bid to €11bn (Bloomberg)

Tesla co-founder’s battery recycling start-up closes in on $5bn valuation (FT)

Novartis plans $15bn buyback after failing to find deals (FT)

Ex-Citadel duo raise $1.85bn for hedge fund (Bloomberg) 

Wall Street banks ditch bullish dollar bets over ‘soft landing’ hopes (FT)