Flexibility Is Key to Weathering Credit Conditions

May 5, 2008

The U.S. transaction business is struggling like a lumbering bear in springtime looking for berries. Fortunately, some private capital investors are finding unique ways to invest in a difficult M&A environment even if it’s not in the traditional leveraged buyout.

A myriad of private investors from middle groups to larger tier players are seeking to generate returns from pursuing different geographies to tapping into specialized investment areas including the purchases of hung LBO debt or investments in infrastructure. Take FondElec Capital, a Stamford, Conn.-based private equity firm that is building up a platform company focused on Brazil’s ethanol industry, or Boston-based Summit Partners and Advent International, which each recently raised European-focused funds or the debt opportunity vehicles being raised by THL (Thomas H. Lee Partners) of Boston and Providence, R.I.-based Providence Equity Partners.

Entering new investment areas or investing abroad isn’t for every firm. But, the flexibility to make untraditional investments or diversify an investment style amidst a challenged economy and tough credit markets is what can differentiate certain investors from the crowd which, let’s face it, sounds awfully similar most of the time, especially when it comes to marketing spiel. Deploying capital when others are looking inward and focusing their attention on portfolio investments takes a certain amount of courage and insight, not to mention the approval of limited partners, but investing when others sit on the sidelines can produce attractive returns. Just ask New York’s Apollo Global Management, which built a good portion of its business on investing in distressed assets and, in turn, produced attractive returns.

Meanwhile, the virtual tsunami of restructurings that some industry participants predicted would rip through corporate America and private equity portfolios this year may not come so soon after all. Financing arrangements may not trip covenants for some time. Credit rating agency Moody’s Investors Service, for example, revised its 2008 default forecast to range from 3% to 4% this year.

Putting money to work in the meantime may just be not only what helps a diversified private equity investor generate returns, but raise capital for the future. And, whether private fund managers like to admit it or not, raising the next limited partnership is almost always what is on the mind, or least in the back of mind, of most LBO dealmakers.