149. What Distributor Roll-Ups Will Become Zombies?

Private Equity (PE) Distributor Roll-Ups: The Good, Bad, and Ugly

PE Good News:

In ’08: The Central Banks rescued PE firms from their over-paid, over-leveraged ’07 deals. By lowering interest rates to near-zero for 10 years good things happened:

  1. PE’s refinanced high-interest debt to low-interest, covenant-lite loans.
  2. Added to their roll-ups with easy financing.
  3. Sold roll-ups to higher bidders as all asset classes reflated globally.
  4. Got great, 10-year ROI results.
  5. Meanwhile: Pension funds (that traditionally invested in bonds often by law) got pitiful returns to become critically underfunded.  
  6. Solution: increase risk/reward by investing into latest/biggest PE, Hedge, and Venture Capital funds.
  7. These gamblers now enjoy their 2% management fees; but where to invest record amounts of “dry powder”?    

The Bad News:

After 35+ years of rolling up industries (including distribution channels), what’s left to buy? Too much cash is now chasing fewer, less appealing, and overpriced deals. So, PE “financial engineering’ is getting edgier, starring: “parcel passing” and “dividend recaps”.

When a PE firm closes a fund, they sell their residual roll-ups to another PE firm’s new, cash-rich fund. The Financial Times calls these deals: “passing the parcel”. Many distributor roll-ups have had multiple, sequential PE owners. Is each adding more value?     

Ugly (Dividend Recap) News:  

Fund managers (who are desperate for higher-yielding bonds) are now buying Collateralized Loan Obligations (CLOs). CLOs are a blend of high-risk loans that now include “dividend recapitalization” loans from PE firms. The latest PE recipe: overpay for a deal, then recoup your equity investment via management fees and dividends financed by risky loans that go into CLOs. If markets tank, the PE is whole. If another Central Bank bailout happens, you get 20% of a rescue up.

Questions:

  1. Will more PE firms exploit dividend-recap loans before the everything-bubble pops?
  2. How many distributor roll-ups are now zombies? (A company so indebted that it can only pay interest on its debts and cannot repay the principal.  Forget digital innovation needs!) 
  3. Will PE’s left holding the zombie (with no higher bidder) become long-term managers who reinvent service value and productivity, and new digital channel-model strategies?
  4. What attack plans have best-run competing distributors aimed at the zombies?

But, why worry? The CLO market is back. Low-interest music is still playing. Keep dancing!

Leave a Reply