Cathy Chan and Patricia Kuo
Nov. 15 (Bloomberg) — TPG Inc. founding partner James Coulter said funding for leveraged buyouts may recover early next year as banks seek to bolster fee income after the U.S. subprime crisis caused them to slow such loans in the past four months.
“Somewhere around January, leveraged finance people are going to wake up and say they need some pipeline and the market will come back,” Coulter said at a private equity conference in Hong Kong today. TPG, formerly known as Texas Pacific Group, manages about $15 billion.
Bankers of buyout firms are unable to sell an estimated $300 billion of debt for LBOs and are asking higher pricing to fund future buyouts. Carlyle Group co-founder David Rubenstein today said buyout firms need to secure new sources of funding from sovereign wealth funds, pension and hedge funds.
As the fallout from mounting U.S. mortgage defaults spreads into global credit markets, investors have shunned the high-yield debt that buyout firms use to fund takeovers. Coulter likened conditions in the buyout market in past months to “a little bit of a typhoon.”
“I suspect our cost of capital would go up about 200 basis points, but this doesn’t mean public to private” deals “are going to go away; it means our strength will go down very substantially,” Coulter said.
Blackstone Group LP President Tony James, speaking at the same event later in the day, said problems in the credit market aren’t “long-term,” and that he also sees “moderate signs of recovery” in leveraged finance. He said he’s more concerned about the bad image of private equity.
Leveraged buyout debt typically costs more than 200 basis points above benchmark lending rates. A basis point is 0.01 percentage point.
Investors demand an extra yield, or spread, of 5 percentage points above Treasuries to buy new U.S. high-yield bonds. The spread reached 5.03 percentages points on Nov. 13, the highest in four years, according to Merrill Lynch prices.
Coulter expects deal volume next year will be higher than people think though the type of deals will be “radically different” from what it has been, featuring fewer investments by buyout firms to take publicly traded companies private.
James said asset prices are “much more attractive” than previously, and that China presents a “fantastic” opportunity for private equity firms. More Chinese companies will make overseas acquisitions with private firms, he said.
Rubenstein, speaking at the same conference, predicted private equity returns will fall. The top 25 percent of U.S. private equity companies returned about 32 percent during the past year, he said. The Standard & Poor’s 500 Index climbed 5.3 percent.
“Private equity return levels will probably come down,” Rubenstein said. “It’s unlikely we’ll do as well as in the past couple of years.”
Still, he said there’s a “very significant” gap between private equity and stock market returns.
Rising borrowing costs forced Cerberus Capital Management LP to abandon a buyout of United Rentals Inc. yesterday, the firm’s second scrapped deal in less than a month. New York-based Cerberus withdrew its $6.2 billion offer for Affiliated Computer Services Inc. in October, citing difficulties selling debt to fund the deal.
As the U.S. housing market continues to slow, driving more downgrades on debt linked to subprime, Coulter expressed concern the mortgage market meltdown will cripple consumer spending.
“I am pretty worried about the U.S. consumers in particular and the knock-on effect” of the credit crunch, Coulter said.
Amid the gloom, Dallas-based TPG is seeing investment opportunities in companies that haven’t yet sold shares to the public, Coulter said. The buyout firm also may invest more in Asia next year, he added.
“There is a risk premium and a growth premium” in Asia, Coulter said.
TPG bought a $30 million stake in ShangPharma Corp., the second-biggest Chinese drug research contractor, the Shanghai- based company said in October.
The private equity industry is now in its “third pause mode,” Rubenstein said. The industry had faced challenges in the early 1990s, which were marked by failed corporate buyouts, and during the technology bubble in 2000-2001.
Apart from the credit issue, private equity firms also face challenges ranging from high-asset valuations, protectionism in Asia and increased competition from investment banks, sovereign wealth funds and pension funds, Rubenstein said.
“We really need to develop a way to joint venture with some of these people who are competing with us, not view them as enemies, but view them as potential allies and find a way to develop a new private equity model,” he said.
Rubenstein said a weaker dollar was a “serious issue” for private equity firms.