(Bloomberg) — Private equity firms' strategy to reorganize assets to buy more time for investments to mature is showing signs of faltering.
More than 100 so-called succession funds were raised between 2019 and 2021 to move portfolio companies from a private equity vehicle to new ones backed by fresh capital. Some are now in trouble amid a sluggish deal environment and declining asset values.
Enviva, a wood pellet supplier that Riverstone Holdings introduced in 2020 continuation vehicleemerged from bankruptcy in December with a restructuring deal that cut $1 billion in debt and gave control of the company to a new shareholder.
Wheel Pros, a tire maker doing business as Hoonigan, also emerged from Chapter 11 last month in a restructuring deal that handed ownership over to a group of lenders. Clearlake Capital Group moved the company to a continuation vehicle in 2021.
Cracks are appearing elsewhere.
Revelstoke Capital Partners liquidated Upstream Rehabilitation at $660 million continuation vehicle in 2019 to fund its strategy to consolidate the physical therapy market. But Revelstoke downgraded Upstream in recent quarters as its revenue deteriorated, according to private financial documents seen by Bloomberg. Upstream public debt is trading at levels that suggest financial stress, with one secured loan due to trade in 2026 at about 83 cents on the dollar, according to data compiled by Bloomberg.
Private equity firms are increasingly turning to ongoing funds to help them hang on to prized assets longer if they believe there is more upside, need more time for a turnaround or want to wait for a better climate to sell. The industry has unloaded fewer portfolio companies since the Federal Reserve began raising interest rates in 2022.
“Exit markets continue to be limited,” Conrad Axelroda partner at the law firm King & Spalding, said in an interview. “We've had extended holding periods and rising secondary sales for at least the last five years.”
A succession fund typically has half the lifespan of a traditional buyout fund — about five years — meaning many of those raised in 2019 and 2020 are reaching maturity. Investors in those funds will be scrambling for sales or other ways to recoup their money, though not all may be able to get out.
Some of the biggest limited partners, public pension funds, have brought in additional help to better manage their increasingly complex investments, including going concern vehicles, according to people familiar with the matter. The California Teachers Retirement System and the Los Angeles County Employees Retirement Association are among those that hired consultants and other specialists to help them with the often byzantine deals that PE firms use to extend the lives of assets.
Lacera, which managed about $82 billion in pensions as of November, recently set aside money for a newly created role that will oversee operational due diligence on its private markets exposures, according to a person familiar with the matter.
“The days of writing checks and waiting for an exit and your money are over,” said Jean-Philippe Boige, managing partner at Reach Capital, a private market fundraising firm. “LPs need to be as informed as possible as there is more financial engineering and leverage being pulled from PE now.”
The pension funds declined to comment.
In Upstream's case, adjusted quarterly earnings fell steadily in the 12 months to June, according to financial documents seen by Bloomberg. During that period, Revelstoke lowered its Upstream investment return estimate to 1.75 times from 2.47 times.
The debt market takes a tougher view of Upstream, which describes itself as “the largest provider of outpatient physical therapy in the US.” The company's secured loan due in 2026 is yielding about 19%, data compiled by Bloomberg show, implying significant risk of default and financial strain.
Debt held by other PE-owned companies that have gone into going concern vehicles in recent years shows similar signs of strain.
United Site Services, a portable restroom provider backed by Platinum Equity, has a senior secured term loan due 2028 trading for about 63 cents on the dollar to yield roughly 23%. The PE firm turned the asset into a going concern in one 2021 transaction which valued United Site at $4 billion.
Adjusted earnings for the company's third quarter fell 26% to $52 million from a year earlier, according to a person with knowledge of the matter. These results follow a September distressed debt swap that United Site pursued to buy more time for repayment.
Audax Private Equity raised $1.7 billion in 2021 to expand ownership of several portfolio companies, including Innovative Chemical Products Group, whose second secured loan due in 2028 yields about 27%.
“ICP Group's performance is not reflective of the broader portfolio of ongoing funds, which has grown nearly 40% in value since its inception,” an Audax spokesperson said in a statement. “While ICP has faced industry headwinds in recent years, Audax has adopted numerous operational initiatives that have driven margin recovery and positioned the company for long-term growth.”
Owning portfolio companies with lower valuations or trading debt at distressed levels doesn't necessarily mean private equity firms can't eventually turn things around.
The Fed's rate cuts and an uptick in deal activity in the second half of last year could help the industry find its way out of the deal drought. And pockets of concern aren't likely to slow down a market that has grown so dramatically in recent years.
While there has been a “blowback” in the secondary market, the asset class continues to perform well, said Isabel Dische, partner and head of the alternative asset opportunities group at Ropes & Gray.
“Deal volume will continue to grow,” she said, “and will probably continue to grow in the years to come.”