When a Buyout Bidder Has Cash to Burn, Make It Pay

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Private equity firms have heaps of cash and they’re hungry for megadeals that will put it to work. But big fish are scarce and likely to be expensive investments offering lower returns. So something may have to give if there’s to be a deal between Dutch telecoms company Royal KPN NV and a buyout shop.

Recent suitor EQT AB has more reason than the average private equity firm to deploy its dry powder. It is listed with public-market shareholders. They’ve been very impressed by its ability to raise large funds and earn stable management fees on the assets amassed. The sooner that capital is spent, the sooner the Stockholm-based EQT can embark on the next fundraising, growing this reliable pool of income.

With one transaction, EQT could deploy a lot of equity in a bid for KPN. It could also offer its clients (or limited partners) two bites of the cherry, first via the specific fund involved and then directly as a co-investor, saving on the overall fees.

The main hurdles are the political and national security obstacles that confront any bid for core infrastructure. But assume that EQT, backed by the Wallenberg family, can demonstrate it’s a responsible owner. Can it then dangle a winning price?

KPN used its strategy update on Tuesday to preempt the shifts a new owner would want to make, promising more cost cuts and increased capital expenditure to accelerate the rollout of fiber broadband. A suitor would have to persuade KPN shareholders that a takeover gives them the full value of this game plan up-front. In a sign of confidence, management just bought stock.

Serious bidders know big top-ups are needed on pandemic-hit share prices. Recent European deals have offered premia of more than 50%, equating to mid- to high-teens gains over pre-Covid levels. Suppose KPN shareholders demanded 3.20 euros ($3.81) a share, or 43% over the price before Bloomberg News revealed EQT’s interest (and 26% above the February level). At 19 billion euros debt-free, that would value the group at eight times 2021’s expected profit on the Ebitda measure. This valuation is the industry average for deal attempts in the region lately, according to Bloomberg Intelligence analyst Erhan Gurses.

A future exit would probably have to be via an initial public offering and subsequent share sales, possibly at a lower Ebitda multiple. Furthermore, the buyout firm’s equity returns could be constrained if leverage was limited to three-to-four times Ebitda to assuage stakeholder concerns, as analysts at UBS Group AG reckon would be necessary.

On UBS’s forecasts, a deal around 3.10-3.75 euros per share would culminate in a 10%-plus internal rate of return for EQT. Ambitious private equity firms usually aim for something far better — around 20%.

But this just might be good enough for EQT’s fund investors, and that’s what counts when you’re under pressure to put capital to work. They’ll see a low-risk investment, and may be after diversification with a reputable firm rather than the last ounce of investment performance. If something has to give for deals of this size to happen, it shouldn’t be the target’s resolve on price.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

©2020 Bloomberg L.P.

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