Private Equitys Big Guns Are Tearing Up the Rules on Leverage

(Bloomberg) — As one of the world’s largest sovereign wealth funds warned this week that private equity is “very troubled” right now, a spate of recent buyout deals in Europe and the US points to a possible route out of the mire: The deep shift in how much debt this industry uses to fund its takeovers.

KKR & Co. has been busily dealmaking despite the gloom around President Donald Trump’s tariff upheavals, snapping up a couple of Swedish health specialists in the process. Fellow private equity firm Thoma Bravo, meanwhile, has pulled together one of the year’s biggest buyouts with the $10.6 billion purchase of Boeing Co.’s Jeppesen navigation unit and other assets.

Like KKR’s offers for Karo Healthcare and life sciences company Biotage AB, the Jeppesen deal shows how private equity is targeting higher-quality assets as it looks to put investors’ money to profitable use. But they’ve something else in common, too: Buyers are stumping up most of the finance themselves, with debt taking up a smaller share than was once the norm.

For a private equity industry that’s often pilloried for piling debt onto the companies it buys — or leveraging them up, in finance speak — this is part of a big shift. Back in the not-so-distant heyday of PE, it wasn’t unheard of for buyouts to include 70% of borrowed funding. Even 80% was doable when money was dirt cheap and firms took full advantage to juice their returns.

Since the turn of the decade, and as interest rates have spiked, the proportion of debt on many buyouts has reduced to more digestible levels as cash got more expensive. In recent weeks, a swath of deals shows how far the pendulum is swinging, with equity outweighing borrowed money in multiple cases.

The Biotage deal includes a slug of debt that’s worth only 20% or so of the 11.6 billion kronor ($1.2 billion) deal value, according to a person with knowledge of the matter. The Karo purchase involves a much bigger €1.1 billion ($1.25 billion) chunk of borrowing, but that’s less than the equity check. Elsewhere in Europe, Cinven agreed to buy nutrition specialist Nutrisens, with just a third of it expected to be debt funded, a person familiar said.

Spokespeople for KKR and Cinven declined to comment.

Thoma Bravo’s Jeppesen acquisition, meanwhile, is being backed with a $4 billion loan led by private lenders Apollo Global Management Inc. and Blackstone Inc. A KKR publication last year said overall in PE, debt as a percentage of total capital structures had fallen from about 60% to nearer 35%.

The cause today isn’t just buyers taking fright at pricey debt. Investors in PE funds, known as limited partners, want firms to put more of their money to work in an M&A market that’s been pretty moribund for a while, several market participants say — and they’re willing to sacrifice returns to do this.

More important is that this is evidence of private equity firms willing to stake larger shares when bidding for higher quality companies with solid cash flows, especially at a time of maximum market turmoil. Premium valuations on these businesses also limit the proportion of debt that can be raised without exceeding acceptable leverage ratios, a measure of debt over earnings.

The industry has also struggled to exit many businesses bought at the top of the PE bull market at the turn of the decade, and is wary of repeating errors.

“The sifting process around diligence on potential targets has intensified given the risk factors that are currently at play,” says Jeremy Duffy, a partner at law firm White & Case. “High quality, non-cyclical and less exposed to tariffs are all high on the private equity playbook.”

The spate of deals involving large slugs of equity also has an impact on the banks and private credit firms who are fiercely competing to put their cash to work by backing buyouts — the first group via debt shared out between a large syndicate of lenders and the latter via direct loans often involving only one or a handful of creditor funds.

Private lenders including Apollo and Blackstone won the deal to back the Boeing unit sale at some of the tightest pricing private credit is seeing, with an interest rate of 4.75 percentage points over the benchmark. Thoma Bravo had an option to go with a financing package that included preferred equity, according to a person with knowledge, which would have cut the equity contribution. It decided not to. A spokesperson for the firm declined to comment.

The rebound in markets since Trump relented on some of his initial tariff barrage makes the rivalry to lend on buyout deals more intense, as Wall Street returns to a riskier type of lending that’s one of its chief money spinners.

The private equity industry’s caution about dealmaking and loading too much borrowing onto companies at too high a cost will only be reinforced by the economic backdrop. Moody’s Ratings stripped the US of its top credit rating last week, as fears grow about the country’s indebtedness, Trump’s tariff ructions and the weaker dollar.

JPMorgan Chase & Co. boss Jamie Dimon warned this week against market complacency, arguing that “the people who haven’t been through a major downturn are missing the point about what can happen in credit.”

For now, PE’s buying and improving of solid businesses may start to be preferred to financial engineering, at least for some. Debt investors might even find reasons for comfort in having large equity checks supporting their assets.

“We’ve seen assets with great growth and great cash flow price at a premium level,” says Daniel Rudnicki Schlumberger, JPMorgan’s head of leveraged finance for EMEA. “Sponsor returns are sometimes less driven by debt” and “more by growth.”

–With assistance from Davide Scigliuzzo.

(Updates with detail on debt investors getting comfort from larger equity checks in penultimate paragraph.)

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