J.P. Morgan PE vehicle may be relaunched this summer
The securitization of equity-related alternative investments, as showcased in the novel private-equity fund-backed CDO recently placed for Prime Edge Capital PLC, may be a relatively new concept, but the idea has apparently reared its head before.
Sources say that global private equity behemoth J.P. Morgan Partners launched an $800 million securitized offering last August similar to previous deals that offered bonds in exchange for shares in private equity offerings.
Named Porter Global Private Equity Ltd., the bonds featured a 2.5% sponsorship fee, and were partially designed by Swiss investment bank Partners Group and marketed by Merrill Lynch & Co.
Unlike earlier deals, however, private debt investors had significant enough reservations about Morgan Partners' Porter bonds that the deal was recently pulled from the market so that its terms could be slightly restructured. The deal will be put back into the market later this summer, and sources close to the transaction expressed confidence that it would get done by year-end.
A secure history
In fact, the more recent, highly touted Prime Edge CDO - which received from Standard & Poor's what is believed to be the first-ever stand-alone credit rating for a private equity vehicle, in addition to its insurance wrap from Allianz Risk Transfer - is really just the latest development in an evolutionary process that began in 1999.
At that time, Swiss investment bank Partners Group (which used to employ Capital Dynamics founder Thomas Kubr) sold $719.4 million worth of zero-coupon convertible bonds that, in 2007, can be exchanged for shares in a private equity offering called Princess Private Equity Holding Ltd. The bonds themselves were unrated, but considered investment-grade because of a wrap from reinsurance group Swiss Re.
Partners Group last year complemented Princess with an offering called Pearl Holding Ltd., which was recently reopened with a E 500 million target and is expected to close at the end of this month.
The J.P. Morgan Porter deal, however, was said to be very similar in structure to the Princess transaction, but was riddled with drawbacks despite the attractive concept behind it.
"There was an obvious appeal to the [Porter] deal because it offered the best of both worlds in that it's fixed income as perceived by the rating agencies, but you're still getting some of the upside of private equity," said a private debt buyer from a West Coast insurance house. "The J.P. Morgan structure was a little rich for us, but we like the idea in general."
Another problem was that the partnership interests offered were said to be of relatively young funds, therefore knocking out a number of the traditional private equity secondaries players who might have otherwise been interested in participating.
It is important to note that the Morgan Partners did not seek or receive a stand-alone credit rating on the bonds, although their accompanying insurance wrap from Swiss Re helped them get an unannounced triple-A mark from S&P.
The recent Prime Edge deal is lead-managed by Capital Dynamics and sub-advised by Rainer Marc Frey (RMF) and Hamilton Lane Advisors. Investors on the equity portion of the deal will receive returns on Prime Edge' investments, just like they would on any other private equity vehicle.
Bondholders, on the other hand, will have to hang their hat on having enhanced their portfolio diversity as they will only receive an annual coupon of approximately 7.5% without an additional equity upside.
"The typical bond investor invests in all sorts of transactions because they want diversified assets, but they had usually been prevented from participating in the private equity market," said Jeffrey D'Souza, co-head of global credit derivatives with Deutsche Bank, which arranged and placed the Prime Edge bonds. "What this type of structure does is not only allow bond investors to further diversify, but also greatly expands the pool of available capital for private equity funds."
While Prime Edge has held a formal close with undisclosed European investors, the fund-of-funds is still open until August and could wind up with as much as EURO250 million.
"We did want a bigger deal, yes, but we're more than happy with what we raised given current market conditions and believe we may still add more," Capital Dynamics' Kubr said. "We offered a novel structure and received investments from people who had never before invested in private equity."
The EURO150 million already raised will be invested into a diversified pool of 35 pre-approved European private equity fund managers. Six such infusions have already been made, Kubr said.
One-hundred five million Euros of the deal was sold as 12-year senior notes, which were split into two tranches. The EURO72 million of Class A bonds received a single-A stand-alone rating from S&P, while the EURO33 million Class B notes received a triple-B rating, which is the bottom of the investment-grade grid. All of the senior notes, however, ended up with a double-A rating due to the Allianz insurance wrap.
"The private equity product is generally not capital guaranteed and investors carry the full risk, but Prime Edge is being wrapped, so Allianz is actually taking on the risk," explained Marc Dentand, a tktk with RMF.
The EURO45 million worth of junior notes was sold to a separate group of investors than the senior notes.
While most buy-side players on both the private equity and debt side have yet to participate in securitized private equity offerings, every investor contacted for this story said the potential upside of such a concept is staggering.
Indeed, the dual realities of an expanded private equity investor base and bond portfolio diversification will likely maintain a continuing flow of interesting offerings in the upcoming years. Not only is Kubr planning a stateside version of Prime Edge, but Soody Nelson, managing director and head of the structured finance market value group at S&P, said that the market may not have to wait that long.
"We've started to get a lot of inquiries about this sort of thing from insurance companies, pension funds and banks and other financial institutions," she said. "We're now working on several proposals, and by the end of the year will rate two or three."
S&P is currently the only credit rating agency known to have rated private equity vehicles, although Fitch had shown an interest in the Prime Edge deal. A source familiar with the situation said Prime Edge decided on S&P because its methodology is considered more stringent and, as such, a high S&P rating would provide more validation to the Prime Edge structure than a Fitch rating would have.