Club deals are something of a sticky issue in the private equity world. PE firms don’t mind them because the risk is spread around, and neither do lenders, who also presume less risk with more reputable investors involved. Dry powder levels have skyrocketed, and club deals allow large checks to be written to spend down capital. That said, club deals have been associated with high-profile bankruptcies in recent years. Toys R Us and Energy Future Holdings (fka TXU) come to mind, leaving aside the question of whether they would have survived with only one sponsor involved. According to our recent analyst note, club-sponsored buyouts are actually much less likely to go bankrupt—globally, around 7.2% of club deals go kaput versus 14.5% of sole-sponsor deals.
At the same time, club deals are also deemed less competitive, or at least they once were. The antitrust division of the DOJ investigated a number of high-profile club deals a decade ago, alleging bid rigging. Among the deals investigated were TXU, which went bankrupt following the collapse of natural gas prices, and Hospital Corporation of America, which turned out to be hugely profitable and helped spur PE’s rush to buy hospital chains. In other words, club deals have been criticized for being uncompetitive (nothing really came of the DOJ investigations, by the way) while simultaneously being associated with bankruptcies. Both perceptions stuck, which helped push down the frequency of those deals in recent years.
Between 2000 and 2004, close to 40% of all US non-add-on LBOs were classified as club deals, a percentage that has plunged to only 20% today. One major difference between the timeframes is the nature of the companies themselves, most of which are publicly traded pre-buyout. Share prices leave little room for error today, which also explains the dearth of take-privates more generally. But dry powder is soaring back to boom-era levels, with the added ingredient of much cheaper debt this time around. There’s some evidence that club deals are not only safer (in avoiding bankruptcy, at least) but also perform better than sole-sponsored LBOs. Exit enterprise values for global club deals of more than $1 billion have risen faster than sole-sponsored deals of the same size in the same timeframes.
On top of that, club deals undergo significantly more recaps under PE ownership, including dividends. More cooks in the kitchen means more mouths to feed. In a way, critics of club deals can have it both ways, since dividends do load more debt onto those companies while enriching their backers. The fact remains, however: Club deals go bankrupt less often, despite each involved fund having different exit timelines to worry about. Perhaps they’ll make a comeback, just as mega-funds have.
This column originally appeared in The Lead Left.
Read more about club deals in our recent analyst note.
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