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Comment by danielparsons | Hacker News Reader

I don't understand how PE manages to get debt financing for LBOs? Seems like a big risk for the creditors?

If I buy a corp at 10% net margin for 5x ebidta on 80% leverage, i’ve really paid 1x ebidta. then lets say 20% of revenue was going to R/D and stuff that would only pay off in a few years. I cut all R/D so now its at 30% net margin.

So I can triple my money every year because it’s now generating profits of 3x my original downpayment every year (minus interest payments). After a few years of zero R/D the company has no good products to sell, demand falls, and it’s declared insolvent. Well, I dont care about my 20% equity downpayment because I already got like a 3-9x return. But the debt financers are screwed.

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Yeah, that’s the idea. The loans get bundled up and resold to insurance companies, pension funds, and retail bond investors.

Funds are plenty willing to lend other peoples money to get guaranteed dividends and fee payments and not be left holding the risk. Retirement funds are the bag holder - but they won’t realize till later.

There’s structural pressure to buy from PE because insurance/pension is designed as fixed payout requiring say 7% yield forever. In a world where investment-grade bonds pay 4% and demographics are shifting from net-inflow to net-outflow, liquidity is _tight_. Meanwhile PE was promising 10% a year or whatever (someone call Madoff…) so that was preferable to the hard conversations of the funds failing. At the cost of kicking the can down to the road and making it worse in the future.

If this sounds like 2008 that’s because it is. But bigger and worse, and happening in wayyy more than just mortgages this time.

> don't understand how PE manages to get debt financing for LBOs? Seems like a big risk for the creditors?

Hype aside they tend to pay it back. When they don’t, recovery is streamlined.

Time to pay the piper:

Blue Owl sinks as investor withdrawals halted at private credit fund https://seekingalpha.com/news/4523155-blue-owl-sinks-as-inve...

BlackRock fund limits withdrawals as redemptions rattle private credit https://www.reuters.com/business/blackrock-limits-withdrawal...

I'll sketch a few points to illustrate the inner workings here:

- It's hard to buy a decent company at 5x EBITDA today. A typical EBITDA multiple nowadays is like 10x-15x. (e.g. EQT bought SUSE for $3B in 2023, and the adjusted EBITDA was $240M, which implies 12x EBITDA)

- Debts are tranched. Banks typically get a senior slice, often secured by real assets (a.k.a. collateral), so they can recoup the money even when the company goes straight into a ditch. The real risk lies in the junior loans ("mezzanine"), which demand very high yields to compensate for that risk.

- In a typical PE deal, most profits are earned at exit, not via dividends en route. So managers have incentive to make the target company (look) better for the next buyer, rather than neglecting it.

A more fundamental reason why the situation you describe rarely happens is that PE fund managers treat their operation as an "on-going" business. Lenders are gonna be really pissed if they lose their money. So fund managers try to avoid that scenario to keep the credit flowing for their next deal.

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