If you net out the moral outrage, Nicky "Von" Hoffman's column on the financing for the KKR-TPG buyout of txu in today's New York Observer does a good job of explaining the private equity-banking food chain. As Hoffman explains, bankers want fees from private equity firms, and they get some of the highest from arranging bond issuances. In order to get those bond deals, however, they've got to offer the private equity firms and the companies they buy all sorts of sweetheart deals, including bank loans on very favorable terms and equity bridges when the money isn't quite there to get a deal done.
The first question is: Where did KKR and Texas Pacific get all the money? Successful as both entities have been in previous deal-making, buying this utility was a stretch. Left to their own preferences, you may assume that KKR and Texas Pacific would each have wanted to go solo, but the two investment funds obviously couldn’t come up with enough scratch to do it by themselves.
To swing the deal, which required $8 billion in up-front cash money, The New York Times reports, “Kohlberg Kravis and Texas Pacific are each putting up about $2 billion in cash. Goldman Sachs, Lehman Brothers, Morgan Stanley and Citigroup plan to invest $3 billion from their private equity firms.” That takes them to $7 billion—$1 billion shy of what they needed.
One more investor was required for that last billion. The last investor turns out to be J.P. Morgan Chase, Morgan Stanley and Citigroup. These same banks will be handling the $24 billion in loans that KKR and Texas Pacific need to finish paying for TXU. (The buyers are also taking on the $13 billion in debt that TXU already had, and that brings the total cost up to the $49 billion sale price.)
The way to deal with such quibbles is to give this kind of loan a respectable-sounding name: Hence the term “equity bridge.” The idea is that, after the banks have bought their billion dollars’ worth of stock in the company, KKR and Texas Pacific are obliged to find somebody or some equity or hedge fund that will take the stock off the banks’ hands. Be that as it may, the “equity bridge” buy-in looks like a “pay to play” operation, as one Wall Streeter put it.
Pay-to-play has been a recurrent source of scandal in public financing. Whether what’s going on here is, legally speaking, pay-to-play is best left to the lawyers, but it stands to reason that if TXU’s bond business is restricted to insider-trackers, somebody’s going to lose out. If it isn’t the banks, the bondholders, or KKR and Texas Pacific, then the most obvious candidate will be whoever pays the household-utility bills.
The banks are willing to buy into a company they plan to lend money to because these bond deals are so lucrative. Last year, KKR alone, according to The Times, paid various banks fees amounting to $837 million. The banks will convert the loans they’re going to make to KKR and Texas Pacific into bonds, many of which will be sold, while some others will probably be kept in their vaults.
A Deal That Smells to High Heaven [New York Observer]