In the rarefied world of private equity, they talk about vintage. The first thing a privateer will ask you about a deal is "what vintage is it?''
If the deal was done in 2002, there is every chance it will have been a good deal; 2002 is a fine vintage. If it was done in 2008 however, it will almost certainly have been a dud.
The quintessential private equity play is to take over a company, strip out the cash, replace it with debt, take the sledgehammer to costs and prepare to float the asset again on the share market - for a humungous return - on a three to five-year time frame.
The high-water mark for private equity was 2006 when some 20% of takeovers were done by privateers such as KKR, CVC, Champ and Archer Capital. The financial engineers follow a similar model and can also be considered private equity of sorts, hence their present distress.
Most of the deals done in 2006 and 2007 could already be deemed failures. Thankfully, the Allco pitch for Qantas failed before take-off. James Packer's sale of Nine Network via half a stake in PBL Media to CVC Asia Pacific, meanwhile, is but one deal that's deep trouble for the privateers.
The vendors timed their sales beautifully, although Packer then promptly geared up his gaming play Crown at the top of the market and that's hurting. For the buyers though, leveraging up the media assets to some six times EBITDA is proving more painful, especially for Nine. Formerly the leading network and a licence to print money, Nine was recently refinanced after a near-death experience.
Private equity only succeeds by dint of rising asset prices and in a climate of abundant debt. Now, debt finance is scarce are expensive, and asset prices have been plunging.
Coal vs Coles
That puts the acid on every leveraged player and the biggest deal done at the top of the market was Wesfarmers' $19 billion acquisition of Coles. Wesfarmers' boss Richard Goyder has effectively bet the company on Coles.
Thankfully, it is a supermarket play and people need to eat, but the pricing was struck at a time when coal prices (coal represents one-third of Wesfarmers' earnings) had gone through the roof.
Coal prices are now going through the floor, as is Wesfarmers' stock price, which was $45 at the time of the Coles deal but is now below $17.
This week's quarterly trading update showed the best first quarter in Coles' food and liquor retailing since 2005. It appears, on the face of the comparable store growth numbers, that Wesfarmers is having a decent crack at turning Coles and Target around.
Coal however was worse than anticipated, suffering sharply lower prices and volumes. Bunnings was travelling quite nicely, although the outlook for retail is not good.
Against this, the critical issue for Wesfarmers - as with any highly-leveraged play - is the matter of financing. It dwarfs all else. WA's biggest company needs to refinance $2.2 billion in debt by the end of this year and another $5 billion by 2010. Meanwhile, earnings will deteriorate and Goyder and Co will probably need to raise at least at least $4 billion in fresh equity.
It can put $1.6 billion in the tin via a DRP (divident reinvestment plan) underwriting but trading is typically weak during DRP periods and the shorting ban is due to come off Wesfarmers on January 27 - in a few days that is. The shorts will be licking their lips every time the stock prices pops up.
Thanks to its insurance business, Wesfarmers is considered a financial stock, thereby included in the shorting ban.
Babcock
Meanwhile, to the state of play for Babcock & Brown. A quasi-private equity player, B&B managed to turbocharge the returns from its deals during the good times by ripping out advisory and other banking fees on every deal.
The foundering financial engineer is locked in a last gasp game of chicken with its bankers. Upping the pressure on the banks to either agree to a refinancing deal or pull the pin and own the debt themselves, Babcock requested a suspension of trading in its shares on Monday.
In early December the banks had agreed to negotiate a complex debt-for-equity deal whereby they would accept a large share issue in lieu of debt. They threw the company a $150 million lifeline to keep trading.
Under the proposal, ordinary shareholders would be diluted almost out of existence, yet the banks could at least punt on a work-out and win some breathing space to sell assets. A debt-for-equity swap would have a manageable impact on the company's capital, though delivering control to the bankers. For Babcock, it could have meant, at a considerable pinch, survival for a while.
There was a major sticking point however - $600 million in Babcock notes - unsecured, subordinated, cumulative, resettable notes to be precise.
Unlike in the US where it would be open to the banks to do a deal with the noteholders and dilute the notes into equity to turn the group around, the rub for the B&B banking syndicate is having to pay out the noteholders at $100 face value - they now trade at a few cents.
Further, most of Babcock's income from deal-doing and from its satellite trusts has evaporated as the satellites split away. And the asset sales program is captive to the dreadful global market conditions.
There is also the matter of varying agendas among the banks, dozens of banks. Some are exposed to the mother ship and satellites, others to the debt at the asset level. It's a negotiator's nightmare, especially as many of the banks themselves are in dire straits.
Even if the $3.3 billion in senior debt, amid the $11.5 billion in liabilities at head company level, could be refinanced it would require the debt-to-equity swap ... a prospect which is diminishing by the day and has led Babcock to suspend in a "put up or shut up" tactic of brinkmanship.
mwest@fairfax.com.au
BusinessDay
