More than $3 billion in bank debt has been churned up recently to drive a trend of private equity firms buying portfolio companies from each other. The practice used to be looked down upon, but it has become increasingly prevalent in the last few months as sponsors look for liquidity, making it a boon for lenders. The traditional options for sponsors--primarily a steady initial public offering market and strategic buyers--are not as available as they once were. "The number of strategic buyers is very limited," stated Mike Finley, a managing director with The Cypress Group. Starting back with the downturn of the economy in 2000, strategic buyers really pulled back from acquisitions and focused on internal issues such as deleveraging their own balance sheets, Finley said. So sponsors are taking each other out.
In the latest example of sponsors' company-swapping, The Cypress Group is buying Communication & Power Industries (CPI) from Leonard Green & Partners for $300 million, joining a roster of other sponsors selling to--and buying--competitors. Texas Pacific Group is buying Kraton Polymers from Ripplewood Holdings and Madison Dearborn Partners is buying Great Lakes Dredge Dock Corp. from Venture Holding Co., a portfolio company of Citigroup Venture Capital, for $340 million. UBS, Bear Stearns and Wachovia Securities are providing the financing on the CPI transaction. Goldman Sachs and UBS are leading the Kraton deal and Credit Suisse First Boston and Lehman Brothers are leading the Great Lakes deal.
Such deals were never very popular due to the "chump factor," according to Richard Carey, a managing director within CSFB's loan group. "The buyer was fearful that they would look foolish for enriching the selling LBO sponsor if the deal turned out badly," he explained. "That [idea] has largely gone away and it's perceived to be a good way to create liquidity for a selling sponsor." The ability of many of these companies to sustain leverage is a force behind the increase in sponsor-to-sponsor sales, Carey noted. Additionally, "They got spreads tighter than they would have if they were brand new LBOs." A buysider agreed, noting if the company has proven it can function in a leveraged environment, then it is a lot less suspect.
Another factor behind the increasing acceptance is that deals between private equity companies have been the more successful transactions completed this year, Carey said. Many of the round two LBOs have been a hit. For example, earlier this year, CSFB and Bank of America led the financing backing Warburg Pincus' $1.2 billion acquisition of TransDigm Holding Co. from Odyssey Investment Partners. Odyssey bought TransDigm from Kelso & Co. in 1998.