Hellman & Friedman engineered a strategy that allowed it to cut its stake in Verisure via an IPO.
(Bloomberg) — Private equity firms are facing a double dilemma. IPO markets, the usual path for exiting investments, have been gradually reopening, but not enough for them to cash out completely. Option B for getting paid, borrowing the money by putting it on the company’s balance sheet, will only make the first problem worse by spooking equity investors.
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Enter Hellman & Friedman, which engineered a strategy last month that allowed it to cut its stake in security company Verisure Plc via an initial public offering and raise €1 billion ($1.2 billion) for a payout by issuing debt from a special-purpose vehicle that sits outside of Verisure’s balance sheet.
Now, analysts say the approach could become a model for other buyout firms that have struggled to return cash on investments made during the era of cheap financing and near-zero interest rates.
“Private equity firms are having to be more creative about generating returns upfront,” said Jonathan Parry, capital markets partner at White & Case. “We’re not at a stage where owners can sell large chunks of their holding at IPO.”
Other buyout firms have previously used margin loans to pay dividends, which tend to be cheaper for borrowers, but shorter dated and allow banks to demand repayment under certain conditions.
In H&F’s case, the deal is unusual because of the type of debt raised, called payment-in-kind, and that it was done at a holding company level on a minority stake. As well, there are no repayment triggers on the PIK debt.
“We are certainly seeing PE sponsors seeking to get creative to take advantage of what are extremely frothy equity markets,” said Alex Robb, a finance partner at Ropes & Gray. He said there are likely to be fewer cases of margin loans being used by buyout firms and more bespoke options to add leverage at holding company levels.
The upshot of this process is that H&F pockets quick cash as it waits for a bigger payday when the shares can be sold. One of the problems in the industry is that stock investors have been wary about buying private equity-backed companies burdened by debt, forcing sponsors to sit on their stakes for longer.
As a result, one increasingly popular strategy in private equity-backed IPOs has been to sell primarily new shares and use the proceeds to pay down the company’s debt. The hope then is that lighter debt load helps propel the stock higher after the IPO, allowing the PE firm to drip-feed its stake to the public market.
