Debt worries ripple through Milken’s dealmaking soirée
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In today’s newsletter
Dealmakers warn of debt woes
Investors get to know Buffett’s successor
Masters of the universe worry higher rates will empty their pockets
At Mastro’s steakhouse last Monday, Michael Milken had a unique way of describing a disconnect hanging over the $10tn private capital industry.
The junk bond king whose Drexel Burnham Lambert catapulted the careers of many Wall Street billionaires, shared an anecdote about photography group Shutterfly.
An Apollo Global fund Milken owns had marked its investment in the company at about the cost it paid to take it private in 2019, but Milken noticed that its loans were trading at about 40 cents on the dollar.
If Shutterfly’s equity was worth full value and its senior loans were trading at distressed levels, maybe Apollo should buy more of its debt, Milken joked at the dinner held during his eponymous conference in Beverly Hills.
It was a good way of explaining the “suspended animation” many feel in private markets as surging interest rates have altered the calculus of an epic wave of buyouts. The costs are rippling through leveraged balance sheets, but markdowns, distressed sales or restructurings have only been episodic.
In public panels and private meetings at the Milken Institute Global Conference last week, financiers said times would soon change. The stresses of higher debt costs are setting in.
“I still think people are too happy here,” said Katie Koch, chief executive of bond manager TCW Group. “Things will get worse and there will be massive opportunities. The greatest wealth creation opportunities come out of a recession and excesses.”
It is basic maths that increasingly gnaws at the masters of the universe.
Steven Tananbaum, founder of GoldenTree Asset Management, presented an analysis that showed the typical leveraged buyout had seen its interest costs as a percentage of operating cash flow rise by 50 per cent, while coverage ratios had fallen by a similar measure.
Base rates, once zero, are more than 4 per cent, while spreads have increased by about 2 percentage points, roughly doubling overall interest costs.
“Today people are relatively complacent,” said Peter Stavros, co-head of KKR’s private equity business, who called rising debt costs “dramatic” and warned: “If it were to stay like this for years, we have a problem.”
Senior loans in recent financing packages have contained payment-in-kind options, noted the veteran dealmaker, who said those features normally were reserved for junior debt and reveal the burden of higher debt costs.
“I have never seen it in my career,” said Stavros. “It is certainly not sustainable.”
“We had kind of a 12-year party in the financial world and private equity. It was a lot of fun and very lucrative and made us all look smarter than we are,” said Jonathan Sokoloff, managing partner of Leonard Green. “The party is over” he said.
Milken’s cameo at the Jefferies dinner hinted at an emerging arbitrage as private equity firms buy back distressed-priced debts in companies they own. But the billionaire who brought leveraged finance to the mainstream expects bigger stories to emerge.
“You are going to have a lot of opportunities in the debt markets in the next year. That is for sure,” Milken told DD’s Antoine Gara after wrapping up his conference.
Berkshire investors warm up to the new guy
It’s the nightmare for more than one Berkshire Hathaway shareholder: waking to the headline “Buffett Kicks Bucket”.
Fears over how long the 92-year-old will be at Berkshire’s helm have stalked investors for years. But at this year’s annual meeting in Omaha shareholders got their best view yet of the man whom Warren Buffett regards as the answer to the succession question: 60-year-old Greg Abel.
Abel appeared more confident in his answers to shareholder questions than last year, if lacking the folksy charm that has long defined Buffett’s style.
He was grilled on the performance of rail operator BNSF, which suffered a derailment in March, and spoke knowledgeably about a separate incident after the railroad was found to have trespassed on tribal land for nearly a decade. Abel said shareholder criticisms were valid.
The forthright response may sit well with the company’s shareholders, who each year are reminded of Buffett’s 1991 congressional testimony over Salomon Brothers’ bond trading scandal.
“Lose money for the firm and I will be understanding, lose a shred of reputation for the firm and I will be ruthless,” Buffett famously said.
How Abel is perceived is critical, not least because Berkshire’s reputation — hand-in-hand with Buffett’s — has helped get the company a first look at deals and convinced potential targets that they would be better managed under Berkshire than rival bidders. Some analysts have also argued the halo has offered Berkshire leeway to disclose less financial information about its divisions or engage less willingly with its shareholders than the typical publicly traded company.
Getting more time with the media-averse executive is top of mind for other shareholders, given much of Buffett’s approach to investment has already been laid out in letters and his speeches over the past six decades. Investors want to see how Abel has absorbed it.
For Berkshire investors able to read through the company’s latest results — a long, financially-dense report put out just two hours before the meeting began — there were a handful of nuggets.
Berkshire remained a net-seller of stock, cutting its stake in oil major Chevron, among others. Instead, it bought back Berkshire shares and watched its cash pile grow to $131bn. The company is earning more than $1bn a quarter on that cash — potentially $5bn this year — a sum its chief executive noted would offset earnings declines at the majority of its businesses this year.
Job moves
Jefferies is hiring David Dolezal, Kyle Baker and Jeff Tang from Guggenheim Securities to boost its energy transition team, Reuters reported.
BDA Partners has hired Dominik Woessner as head of private capital advisory secondaries in Singapore. He previously worked at Lazard and Greenhill.
Smart reads
New Russian oil route While the EU imposed a series of restrictions on Russian oil following its full-scale invasion of Ukraine, India opted to increase its imports. Now a little-known company called Gatik has become an international oil shipping giant, the FT reports.
Nygard vs Bacon The FT explains how a gated community feud between clothing mogul Peter Nygard and his billionaire hedge fund manager neighbour Louis Bacon turned into a $203mn defamation payout.
The CrackBerry story Matt Johnson’s new film BlackBerry shows that a rise and fall is more gripping, and more morally provoking, than pure success, the New Yorker reports.
News round-up
KKR earnings slide on slowdown in dealmaking activity (FT)
Warburg and Advent to acquire Baxter’s biopharma unit (Reuters)
Fate of SVB’s Chinese venture hangs in balance (FT)
Canaccord’s management buyout at risk (Reuters)
Australian fund buys $660mn stake in European mobile towers (FT)
UK biotech start-up raises $130mn (FT)
US hedge fund manager buys stake in Birmingham City (Bloomberg)
Due Diligence is written by Arash Massoudi, Ivan Levingston, William Louch and Robert Smith in London, James Fontanella-Khan, Francesca Friday, Ortenca Aliaj, Sujeet Indap, Eric Platt, Mark Vandevelde and Antoine Gara in New York, Kaye Wiggins in Hong Kong, George Hammond and Tabby Kinder in San Francisco, and Javier Espinoza in Brussels. Please send feedback to due.diligence@ft.com
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