Private equity deal makers succumb to 'cocaine' of debt

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Debt has become the "cocaine" of the private equity market, with leverage levels increasing by nearly a fifth in the past year and bank borrowings hitting record levels.

This has led to industry experts predicting an "accident", such as a big deal going bust.

According to data from Standard & Poor's, the credit-rating agency, borrowings for buy-outs totalled €56bn (£38bn) in the first half of this year, compared with €65bn for the whole of 2004 - making it likely that 2005 will break all records for leveraged buyout debt.

S&P figures show that the average loan was worth 5.5 times the earnings before interest, tax, depreciation and amortisation (Ebitda) of the business being bought, compared with 4.6 times Ebitda in 2004.

Senior financiers said these levels did not surprise them. One explained that he had seen deals financed with loans totalling nine times Ebitda, with recent high-profile transactions, such as ABN Amro's £875m purchase of the Priory chain of clinics, carrying debt of seven times Ebitda.

Tom Lamb, managing director of Barclays Private Equity, said "seven was the new five" for financing. "Everyone is looking at everyone else saying this cannot go on. But it will take an event, like a collapse or a deal going wrong, to stop it."

Another senior financier, who did not want to be named, said: "Debt is the cocaine of the private equity industry. Everyone says it is not a problem for them, but if everyone is using it in large quantities then it will be a massive issue."

Much of the growth has been caused by the massive supply of finance in the market. This year it is expected that private equity firms will raise €30bn from investors, with BC Partners being the latest to raise a multi-billion-euro fund.

Banks have been falling over themselves to lend to the sector, while hedge funds have been on hand to snap up the more complex financing instruments.

Many private equity players in the market say they have walked away from deals because of the high prices being paid.

"We have seen some deals that appear over-leveraged and we do get outbid as a result," said Tim Lebus, a director of Duke Street Capital. "It feels likely that at some stage there will be an accident."

Until recently, the high levels of borrowing were largely confined to the top end of the market - deals of £1bn or more. However, the strong competition among financiers has moved large-scale leveraging into the mid-sized deals of between £200m and £1bn.

"Private equity players have a lot of money to spend, and they have to spend it," said Will Rosen, a partner at lawyers Weil, Gotchal & Manges.