PE firms look to go it alone as credit units reach maturity
Michelle D'Souza
March 2020 | Issue 221
Private equity firms are starting to weigh up the merits of housing private debt businesses, with TPG Capital the latest to contemplate splitting with its credit business TPG Sixth Street. It follows EQT Capital, which announced a strategic review in January centred on parting ways with its credit unit.
There can be an economic angle to such splits, depending on how capital is divided, says Jeff Davis, managing director of financial institutions at Mercer Capital in Nashville. "Private credit arms have grown substantially, and the asset class has a strong hand to play. There can be a partnership up until a certain size and complexity. But at some point, that model probably doesn't make sense." Other private equity sponsors have taken similar paths, attracted by the diversity afforded by credit and the ability to leverage existing relationships with portfolio companies. But sources say the growth of credit has made it difficult to manage conflicts between debt and equity units.
Most firms have walls in place to create some form of partition with respect to information flow and decision-making. But the walls will evolve with the businesses, which may result in a loss of synergies that could outweigh the advantages of reducing conflicts, sources say. Credit arms may wish to use due diligence conducted on a company by their PE counterparts, but sharing material non-public information is not an option. Therefore, independent investment teams, resources and infrastructure are required. Conflicts of interest arise when debt and equity units from the same firm invest in different levels of a portfolio company's capital structure. A limited number of firms — TPG Sixth Street being one — avoid this conflict by not financing any TPG-sponsored deals. Spinning the credit arm out could therefore provide access to debt packages the partner cannot access. If debt and equity units finance and sponsor the same corporate, they may find themselves with competing interests, especially in distressed situations when creditors vote. "Equity investors have different interests in credit," says Davis. "Something that could maximise value for the equity —taking on more leverage for example — may not be in the best interests of creditors." Selling a credit business does not necessarily mean an asset manager stepping away permanently. It is understood that TPG and TPG Sixth Street have a one-year grace period in which they have agreed to not expand into any new, competing strategies.
"There can be a partnership up until a certain size and complexity"
Jeff Davis,
Managing director of financial institutions | Mercer Capital
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