Rising Debt Levels in Private Equity

The private equity market is becoming more hostile as investors demand greater return through calculated risk. With a general decrease in buyout returns, aside from the star outliers like Bain, private equity firms are demanding more from their portfolio companies. According to CNN Money, the activist shareholder is pushing for companies to explore alternatives that will provide higher yields.

Starboard Value, Paulson & Co recently pushed AOL to sell off a large portion of its assets. The sell off provided immediate cash amidst declining ad revenue for the online media conglomerate. This just following the acquisition of the Huffington Post, a major milestone for AOL, which seemed to be on a path of organic growth as the company hired more journalists and segmented its online brands. The demand for quick cash by Starboard forced AOL to reduce overhead by laying off nearly all of its in house writers, and instead opting for the purchase of TechCrunch and Huffington Post. The sudden pick up in corporate activity at AOL highlights the inherent demand for cash during the risky PE shuffle.

Rewind to 2007 when the Economist warned against trouble in the PE market. The magazine cited the risk of rising interest rates causing an uptick in borrowing costs leading to more hostile activity to cover this additional credit expense. This hostile PE market will thereby take on more risk. The difference now is that we have record low interest rates, but low buyout returns. The latter problem is enough to revert us back to the same warning of 2007. Investors are demanding more cash by being hostile in their PE activities.

PE firms are in the business of selling assets, and then flipping companies for huge gains. In some cases, this might involve dismantling a conglomerate, purchasing undervalued companies, executing a turnaround, and then finally an exit through sale. The model involves time and risk, two factors that cause investors to be anxious.

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