KKR's distressed debt deals

There was an odd little deal announced this week that provides further insight into the evolving nature of private equity activity in the post-crisis environment.

Since February last year shares in recycling group CMA Corporation have been suspended from trading on the ASX while the group, which has more than 20 recycling plants in Australia, Asia and North America, has tried, without success, to negotiate a financial restructuring with its lenders.

Enter Kohlberg Kravis Roberts & Co. Sometime earlier this year the giant private equity group acquired $81.9 million of CMA's $120 million of senior debt from ANZ, making it the majority lender to the group.

On Thursday CMA announced a capital reconstruction under which it will raise $5 million of new equity, underwritten by KKR, place $25 million of new shares with KKR and enter an agreement with KKR under which the group will provide executive and management services. KKR, through its asset management division, KKR Asset Management, or KAM, will emerge with between 71 per cent and 85.5 per cent of CMA.

In the context of KKR and the massive private equity deals it has traditionally pursued, CMA is extremely small fry. The nature of the deal, however, points to the new approach being taken by the giants of the private equity sector post-crisis as well as changes in the nature of KKR itself.

The CMA recapitalisation is being undertaken by KAM, which specialises in investing in credit and mezzanine debt and, within KAM, is being managed by its ''special situations'' unit. In other words it is a distressed debt deal rather than a conventional private equity deal.

We've already seen in this market how private equity firms, hedge funds and distressed debt funds have been able to effect reconstructions of over-leveraged entities by buying their debt from conventional lenders at a discount that then enables a sensible recapitalisation to occur where conventionally the entities would have fallen into some form of administration.

The TPG-led reconstruction of Alinta and the proposed restructuring of the Centro group are good examples of the approach. CMA appears a variation on the theme.

For much of their history the major private equity firms did conventional leveraged buy-out deals. That was changing even before the crisis as the big groups started to use their expertise in evaluating companies and assessing their creditworthiness to create specialist funds to invest in debt, particularly lower-grade and more exotic forms of debt and, more recently, debt issued by the companies it has invested in.

They also started establishing specialist funds to invest in unlisted sectors like infrastructure, property or resources, staying in the less liquid ''alternative assets'' space, and started leveraging the sector expertise they had created for their private equity businesses to create advisory businesses. Within KKR there is a business, KKR Capstone, which contains a large group of former senior executives and consultants whose expertise it offers to the companies it invests in, at cost.

During the crisis debt markets froze and asset values plunged. Traditional LBOs were simply undoable and the investments of private equity firms were hit hard, adding urgency to the diversification push by the bigger players and changing the size and nature of those deals they were able to contemplate and the way they were funded.

As in the CMA, Alinta and Centro cases, the crisis also offered the firms a new type of opportunity they could use their wider charters and capabilities to exploit.

KKR reported its first quarter results this week, with a 10 per cent increase in what it terms its ''economic income'' and a 6.5 per cent increase in the value of its portfolio. Like its peers, KKR has been taking advantage of the post-crisis improvements in markets and activity to exit some of the larger positions (like its interest in the Seven Network) and return capital to its investors as well as freeing up the capital it had tied up itself in some of the investments.

Its new post-crisis deals have (and the same could be said of rivals Blackstone and Carlyle) been much smaller than the massive LBO transactions undertaken during the credit bubble, as well as reflecting the shift in emphasis towards debt-focused funds and opportunistic distressed debt deals.

That doesn't mean that there won't be sizeable LBO activity in future – there is said, for instance, to be continuing private equity interest in Treasury Wine Estates, which is about to be spun out of Foster's – but rather that the private equity giants are rapidly evolving into far more diversified and complex institutions than conventional perceptions of them as simple predators would suggest.