Private Equity Firms Are Sinking To New Debts

Private Equity Firms Are Sinking To New Debts
Theodora Lee Joseph, CFA

6 months ago2 mins

What’s going on here?

Higher interest rates have pushed private equity firms into some very hot water.

What does this mean?

Private equity firms are like house flippers, but for businesses. They pool money, borrow some more, buy a company, and then spruce it up – all in the hope of selling it for a profit down the line. But lately that whole “borrow some more” bit has caused trouble, and a number of the biggest players, including KKR and Bain Capital, are feeling the pinch. See, increased interest rates have made borrowing much more expensive recently. Case in point: inflation-adjusted Treasury bonds – a key measure of borrowing costs – have surged to a 14-year peak. The result is that firms are having to hand over their portfolio companies to creditors, and face seeing their investment share and returns in the firms wiped out.

Private equity markets have grown

Why should I care?

For markets: A shame for shareholders.

The days of easy money are gone. No one’s immune to higher interest rates, from everyday mortgage holders to private firms and even public companies. And if you’ve invested in a debt-laden firm, well, you might find yourself at the back of the queue for a payout. See, common stockholders win when shares climb – but when companies can’t repay their loans, they’re often the last ones to recover their money. So as more companies wrestle with their mounting debts, don’t be surprised if valuations for those with sturdy financial foundations pop – while debt-heavy firms languish.

The bigger picture: Cash is king.

Lenders aren’t actually too thrilled about taking over these assets. After all, their business model is simple: lend money for interest in return. So if they end up receiving assets in lieu of cash, it won’t be long before we see a fire sale of unwanted holdings. For cash-rich firms, that’ll mean it’s open season for a good old-fashioned bargain hunt.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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