Availability of cheap debt with few covenants for private equity firms.
Statement: The use of debt is thought to make private equity portfolio companies more efficient. According to this view, the requirement to make interest payment forces the portfolio companies to use free cash flow more efficiently because interest payments must be made on the debt.
Q. If this is the case, then every debt laden company should use free cash flow efficiently and not just private equity firm. What I mean is that the statement above is the reason why private equity is successful using debt. But every company strives to make interest payments duly, isn’t it?
Statement: Much of debt financing for P/E comes from the syndicated loans market, but the debt is often repackaged and sold as collateralized loan obligations (portfolio of leveraged loans)
Private equity firms may also ISSUE high-yield bonds WHICH are REPACKAGED as CDOs. This essentially means that "I am a company. I need funds. I issue bonds. Now I repackage those bonds as CDOs. I had heard of repackaging assets as ABS, but repackaging bond - my debt, my liability - as CDOs…? What does that mean?
I think first statement is just basically that PE firms are capable of obtaining cheap financing for their companies in portfolio. Why? I don’t know 100% sure, but I think it has to do with reputable management, better negotiations with the banks, and probably different interest-type structure and covenants.
I think it’s not so much cheap financing, but rather that the high debt load disciplines management and forces them to allocate capital only to very profitable investment projects, rather than building a fancy new headquarters for example. Of course the logic is not 100% great, because a public company’s management could also be disciplined (but in practice, many are not).
Yep, but maybe is important to remember that the high debt load does not “discipline” management for any reason, but because they’ve put their own stake in the company. That’s what makes everyone disciplined, and that’s why probably mabe managements are not disciplined, cause their money is at home.
Generally PE firms choose companies specifically that are able to shoulder a high debt load. They buy companies with solid, stable cash flows. Even though they put a lot of debt on it, they’ve chosen a business that should be able to pay it down.
But when you’re looking at companies with a lot of debt, you’re looking at a lot of different types of companies. For example, look at all the debt heavy companies in the fracking sector right now. They’re in a deeply cyclical industry and they have a history spending money freely even when they already have big interest payments due.
So short answer: conventional wisdom is PE firms tend to really care about paying down the debt.