Moody’s Downgrades Private Equity

The ratings agency is skeptical of the hype.
Alan RappeportJuly 9, 2007

Private equity has faced all kinds of pressure as the bubbling industry’s profile has grown with bigger buyouts and, lately, public offerings. The latest to weigh in is Moody’s, the ratings agency, which Monday released a “special comment” questioning whether private-equity-owned companies are really any more far-sighted than the managements of public companies when it comes to investing in their businesses.

The report claims that despite their freedom from quarterly earnings reports, private equity firms do not invest over a “longer term horizon” than their public counterparts. Further, Moody’s said it was concerned by the “willingness of private equity firms to issue special dividends despite commitments to reduce leverage,” sometimes within the first year after a buyout. Private equity’s freedom from the short-term pressures of public-equity markets is often credited as one of its prime advantages.

“We’re not dismissing the success of private equity,” Christina Patten, a senior analyst at Moody’s and an author of the report, told CFO.com. “But creditors should be aware that if the current environment changes, if interest rates go up, these deals will not look very attractive.”

The report cites the 2004 buyout of Warner Music, when dividends were paid to Thomas H. Lee, Bain Capital, and Providence Equity, and the 2004 purchase of Celanese, when dividends were quickly paid to Blackstone. Such actions, which hinge on credit markets, may not always be so forgiving. The reasons for such dividends remain unclear, according to the report, but could stem from pressure to increase shareholder returns or the presence of a highly liquid market. But the short-term benefit to shareholders might not be best for companies.

“For a CFO, you might have more capital to invest in other circumstances,” says Patten. “Given the amount of dividend activity today, these companies may have less capital to invest in the businesses.”

In such cases, the benefits for executives hinge upon whether they are shareholders or employees. Those in private equity may feel that the Moody’s report misses the point. “Corporate leaders who have experienced first-hand the positive effects of private-equity ownership are quick to tell you that this structure can and does liberate management to focus on long-term growth,” said Douglas Lowenstein, president of the Private Equity Council, a Washington D.C.-based trade group, in an E-mailed statement.

For its part, Moody’s says it will keep a close watch on the industry’s characteristics when evaluating the risk of high leverage and warns that many leveraged buyouts may need to be refinanced if the economy stumbles or if debt becomes more expensive. Although Moody’s concedes that some of benefits of an LBO can make companies more competitive, the rating agency remains “mindful that the ultimate beneficiary of these advantages may be the private equity firm.”