How do you do jumbo deals when you don’t have much debt capacity and can’t issue equity? Start your own private equity fund. That’s what Bertelsmann, the private German media company, is doing. It is co-investing 500 million euros alongside Citigroup and Morgan Stanley, who will each contribute another 250 million euros. But thanks to the magic of leverage, Bertelsmann could find itself participating in up to 16 billion euros worth of deals in the next few years.
Just look at the numbers. The fund plans to take stakes of 20-30% in media companies, with other private equity groups putting in the rest. That amounts to 4 billion euros of equity. Assuming each deal is funded on a 75:25 debt to equity ratio gives the fund 16 billion euros of firepower. The fund is already reportedly looking at Canadian textbook publisher Thomson Learning, said to be worth 3.7 billion euros.
Bertelsmann is making a virtue out of a necessity. As a private company, it can’t issue equity to fund deals. Nor does it have much debt capacity at the moment. It is loaded with 6.7 billion euros of debt after buying back a 25% stake from Belgian financier Albert Frere last year. That is equivalent to 2.8 times last year’s ebitda — above Bertelsmann’s self-imposed target of 2.3.
But the structure, while novel, looks complex. Trade buyer and private equity partnerships are usually fraught with problems. One is control. Any acquisition made by such a partnership would have to be jointly managed, which can be tricky. Second, private equity groups tend to demand higher returns than trade buyers on their equity. This may not be such a problem for the Germans. Bertelsmann usually targets total capital returns in excess of 10%. In a highly leveraged buyout, that could still be consistent with private equity style returns.
That leaves the biggest problem with these alliances: exit. Bertelsmann would probably be interested in keeping some investments. But negotiating an exit price can be a hairy affair. Still, Bertelsmann can’t be faulted for trying. Given its current incapacity to do big deals, it is certainly better than nothing.