Private equity’s problems explained in one blow-up
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What do veterinary clinics, dental offices, language translation services, customer service chatbots and software used to handle turnstiles for the New York City subway have in common?
These businesses collectively received billions of dollars in investment over the past decade as part of a record boom in private equity dealmaking. But now, as they collect dust in the portfolios of large buyout shops and private credit firms, many are unravelling.
On Thursday, a public credit fund that lent to these types of private equity deals plunged amid mounting financial distress across its portfolio of private equity loans, DD’s Antoine Gara reports.
The fund offers a window into a private equity industry suffering from a vicious hangover.
PE firms, during an era defined by rock-bottom interest rates, went on a deal binge. The pressure to deploy money was so great that firms chased sky-high valuations and conjured ever more cookie-cutter ideas to put growing stockpiles of investor cash to work.
An industry that had once owned corporate icons such as Hilton, Continental Airlines and Broadcom turned its attention to obscure software companies and unglamorous roll-ups of car washes and insurance brokerages.
Many of these deals have limped along for years but a long-awaited reckoning has surfaced at niche publicly listed lending vehicles called “business development companies”.
FS KKR Capital Corporation, a BDC managed by KKR, exemplifies the trend. On Thursday it reported large losses on some of its loans and watched its shares fall 15 per cent after saying it would slash its dividend.
FSK’s portfolio is characteristic of the older private equity deals that are now having their comeuppances.
The BDC wrote down the value of Cubic Corporation, which manages tap-to-pay technology for the New York City subway system and is owned by private equity group Veritas Capital and an affiliate of hedge fund Elliott Management.
Other writedowns included AmeriVet, a network of more than 100 vet hospitals acquired in 2022 by AEA Investors, a PE firm founded with backing from the Rockefeller, Mellon and Harriman families, and a roll-up of dental offices.
The most prominent was the further markdown of Medallia, a customer service software company acquired by Thoma Bravo for $6.4bn in 2022. BDCs reporting earnings this week slashed the value of their Medallia loans to below 80 cents on the dollar.
The deal was part of a surge in software takeovers struck by Thoma and others in 2021 and 2022 that won financing because of groups’ massive equity investments. Thoma ploughed about $5bn of investor equity into the deal.
Blackstone, which also lent Medallia money, said it had appraised the software company’s enterprise value lower by 70 per cent, valuing its loans at a steep discount of 78 cents on the dollar. That implies that Thoma’s equity investment has mostly evaporated.
DD readers are familiar by now with the troubles percolating the private capital ecosystem.
Funds managed by Blue Owl have triggered broader fears that private credit lenders are vulnerable to the software sell-off and flighty investors. A golden age of software returns also faces the existential threat of AI.
But what about all of those grittier PE deals, like roll-ups of janitorial service companies, waste disposal networks, or local HVAC and plumbing operations? They don’t look too hot either.