Portfolio Companies Hurting

By Marc Raybin
PrivateEquityCentral.net
April 3, 2009

That screeching sound you heard early this week out of Washington, D.C. was the Obama administration's very real threat of putting the brakes on more federal bailout money to Chrysler. The White House directed the failing auto company to merge with Italian carmaker Fiat in order to persuade the government to give more cash to the company. Something else happened – Cerberus Capital Management was told its $7.4 billion investment in the iconic American car company was worthless. To be sure, Cerberus, long considered one of the stalwarts of the private equity industry, has not been alone in seeing portfolio companies crash and burn in a growing pile-up of failed portfolio companies.

Chrysler, while the most high-profile of recent private equity portfolio blow ups, is not the only one. Apollo Alternative Asset’s Linens ‘N Things and Madison Dearborn Partners’ Wholesale Liquidators both filed for bankruptcy protection. Portfolio companies are feeling the heat of the recession, as is nearly every other business.

"Portfolio companies that are most in trouble are the ones owned by private equity firms [that] are unable to allocate additional financial resources," says Mark DeGennaro, a managing director at boutique investment bank Gruppo, Levey & Co. "If they don't, they will basically cut their losses and move on."

Fabian Pal, a partner at the law firm of Fowler, White, Burnett, says this issue is tied into the broader issue of transparency. The Bernard Madoff scandal and other Ponzi schemes being discovered now are having deleterious affects on firm’s being able to raise capital, he says. Investors are holding back capital that they normally would have been putting into private equity funds and hedge funds. (Pal cites the newly proposed hedge fund transparency legislation in Congress as being very important to private equity firms since the rules would apply to both asset classes. Any fund with at least $50 million in capital under management would be forced to register and be tied to the disclosure rules.)

"A lot of these private equity funds and hedge funds are having trouble with funding on their end," he says. "Of course, that is affecting their ability to invest in [portfolio] companies."

Contrary to popular belief, private equity firms and venture capital firms do not provide endless supplies of capital to portfolio companies. Pal chuckles at the misconception, saying: "that is not how it works." From the top to the bottom, everyone is feeling the pinch. Just a few months ago even Cerberus told Chrysler that it would not give the company anymore money. Like a parent putting his or her foot down to their leeching child, private equity firms are saying "no mas."

"I have seen situations where companies have found themselves needing a second round or a third round to really launch out to the market and they are cut off," says Pal. "You will see portfolio companies starting to have issues with bankruptcy."

So, what is a struggling portfolio company to do?

Both DeGennaro and Pal say they have seen portfolio companies pleading with creditors to restructure their loan agreements. Terms of their loans have been extended and interest payments are getting reduced. As a result, Pal says these portfolio companies may be forced to find alternate sources of capital in order to avoid bankruptcy and stay afloat. That includes approaching other funds and investors.

Pal also says portfolio companies will continue to be conservative with how they spend their money. Parent firms are also sifting through their portfolio companies in order to divest non-core assets in order to raise cash and help their companies weather the storm.

Still, it is not all bad news for all portfolio companies. The recession is certainly providing good opportunities for the firms that do have capital to spend on their investments.

"[This is a] good time for private equity firms to think about taking portfolio companies and merging them with a competitor," says DeGennaro. "[It is] a good time to pick up some market share and come out as the stronger business down the road."

That’s not all.

"We are also seeing a number of firms interested in making add-on acquisitions," he says. "You can buy add-on acquisitions at very attractive multiples today."

The stock market may be rising of late, but it is still far off from its all-time highs just a year-and-a-half ago. Unemployment numbers are high and that means less money will be spent in the retailing and discretionary consumer spending sectors, DeGennaro says. That means portfolio companies are sure to feel the continued pain until the economy is in full recovery mode. It is hard to know when that will happen – we will probably know it when we see it.