Froth and heady fees have marked the peak of every investment boom in private equity, and the recent credit bubble is no exception. Perhaps the most emblematic deal of the latest frenzy was the acquisition in February 2007 of energy company TXU Corp. by a group led by New York–based buyout firm Kohlberg Kravis Roberts & Co. The transaction, valued at $48 billion, set a record as the largest private equity deal in history and was financed by a whopping $40 billion in bonds and bank loans. (The remaining $8 billion came from private equity firms, including TPG Capital, and bank-owned investment concerns that took part in the consortium, such as Goldman Sachs Group’s private equity arm.)
The Dallas-based company, renamed Energy Future Holdings, has since struggled to manage its debt load in the wake of slumping natural-gas prices and reduced demand for its services. Although the former TXU’s fortunes improved in the fourth quarter of 2009 — it delivered a small net profit of $137 million, versus a loss of $8.86 billion in the fourth quarter of 2008 — it is still in a tenuous position. The company’s executives are now working hard to repair its balance sheet and extend debt maturities: Although relatively little is due in the near term, more than $20 billion will reach maturity in 2014.
This is not the first time that private equity firms have binged on cheap debt and struck deals that arguably never should have been done. Since the modern leveraged buyout business began in the early 1960s, private equity has had three boom-and-bust periods. The first started in the early 1980s and was characterized by feverish buyout activity financed by junk bonds. That boom reached its zenith in 1989 with the $31 billion leveraged buyout of RJR Nabisco by — no surprise here — KKR.
By 1990 private equity had contracted sharply in the wake of insider trading scandals in the junk bond market; it did not regain traction until after the 1991–’92 recession. The first sign of an imminent comeback was Thomas H. Lee Partners’ acquisition of Unadulterated Food Products, the maker of the popular Snapple drink line, for a reported $135 million in 1992; just two years later Lee sold the renamed Snapple Beverage Corp. to Quaker Oats Co. for $1.7 billion.
LBOs promptly surged, and private equity fundraising soared in the 1990s, culminating in 2000, when total commitments reached $245.3 billion, according to London-based research firm Preqin. Activity swiftly collapsed again, however, as the equity bull market came to a crashing end that same year.
The third buyout boom, which began in 2004 and reached its apex in 2007, was possibly the most dramatic yet. Not only were deals huge and highly leveraged — debt ratios climbed as high as 6 times earnings before interest, taxes, depreciation and amortization, up from 4 times ebitda in 2002 — but private equity firms traded on their own performance histories and monetized their partnerships. New York–based Fortress Investment Group made headlines when it went public in February 2007; a few months later New York’s Blackstone Group, an even bigger name in buyouts, did its own IPO.
Since then the stocks of both firms have been hammered, and their senior partners somewhat humbled. As of mid-March, Fortress was trading at $4.40 a share, down 76 percent from its offering price of $18.50. Blackstone was at $14.40, a 54 percent discount to its IPO price of $31 a share.
Perhaps the most startling aspect of the current private equity cycle, however, is how quickly the effects of the crisis seem to be fading as governments pump massive amounts of liquidity into global markets to try to spur economic growth. Deals are on the rise again. Financing is being found. Just last month KKR — ever the leading indicator — announced that its partners plan to tap into the public markets with a listing on the New York Stock Exchange. Whether investors will be tempted to buy in remains to be seen.
