Deutsche Bank on what corporates need to know when Apollo and other PE firms that own life insurers come calling.
Private equity (PE) firms that control the balance sheets of insurance companies are actively seeking investment-grade (IG) assets, a trend that’s unlocking a flexible and customizable source of alternative capital for some corporates—including those that considered PE firms largely irrelevant to them except in cases of outright asset sales.
- “This is a now a new option in the toolkit that you should definitely be aware of,” said Marc Fratepietro, managing director and co-head of global debt capital markets at Deutsche Bank. “It’s largely about the convergence of insurance companies and sophisticated alternative asset managers.” He spoke at the fall meeting of NeuGroup for Capital Markets sponsored by Deutsche Bank.
- PE firms including Apollo, KKR and Blackstone that are moving into the life insurance industry and run multi-strategy asset management arms need longer-dated assets with strong credit ratings and stable cash flows to match against longer-term liabilities, he said. And they are more willing to take passive, minority stakes in a subsidiary or joint venture (JV), giving corporates new alternatives for raising hybrid or minority-stake capital while maintaining operational control and accounting consolidation of a business.
- Prominent deals in this category include AB InBev’s sale of a $3 billion stake in a US can manufacturing business to Apollo in 2020, Brookfield’s deal to invest up to $15 billion in an Intel manufacturing plant last year and Apollo’s $2 billion investment in an AT&T subsidiary preferred instrument in June 2023.
- Uses for the capital raised include delevering, acquisition finance or funding capital expenditures.
Sea change. “The profile of these PE companies and how they think about investing has fundamentally changed to include a long-duration IG model because their insurance liabilities are longer duration and/or they have increased access to permanent capital,” Mr. Fratepietro said. “And that’s a sea change that is much more interesting for investment-grade companies.”
- Accessing this relatively new pool of capital requires active collaboration and coordination between corporate treasury and M&A teams. Corporates may benefit from working with a bank that is active in this space to structure transactions and negotiate with PE firms. “Aside from technical and market knowledge, a bank will bring experience working with both IG corporates and PE firms that can help both sides better understand and navigate respective objectives and constraints,” he added.
Public vs. private. While tapping this source of private funding is not cheaper than financing with publicly-issued capital, IG companies working with PE firms are able to structure unique transactions in ways not always possible in the public market. “The most valuable aspect of this capital sleeve is its flexibility to do off-the-run, customized transactions” that may include limited disclosure, larger sizes and potential ratings, tax and accounting advantages, Mr. Fratepietro said.
- He continued, “These investors can give corporates a size, a certainty and ability to customize structural features and terms that might be more optimal than the public market alternative. And because of a convergence of public and private valuations, you can probably do it at a price that’s reasonable versus the public alternative.”
Bespoke structures, common elements. Mr. Fratepietro said the deals tapping into this source of capital exist on a continuum between M&A-style minority-stake sales and private, hybrid capital placements. “But there is no perfect blueprint for what works; each deal is different and designed to accomplish its own set of objectives; what can be done is not limited to what has been done,” he noted.
- The common feature of these deals is the PE firm is looking to invest in an instrument that is backed by IG-cash flows, he explained. For deals structured as minority stake sales, the investment is usually in the form of common or preferred shares in a JV that has “high-quality cash generative assets and/or or a long-term offtake or supply contract with a well-rated counterparty.”
- That said, “A key thing I tell people is that it’s not just limited to the JV structure. If you have something unusual you want to do in the capital space, talk to a bank that has experience with these transactions because there may be a way to fit what you’re trying to do into the growing pool of capital these multi-strategy asset managers have. There are a number of structural levers on these transactions that a bank advisor can help you understand from a trade-off perspective.”
Understanding the benefits. While the investment may be in the form of equity, this group of investors has the ability to divide risk into tranches in a way that potentially allows a substantial part of the investment to be placed into insurance accounts as a fixed-income instrument, which means a lower cost of capital for the corporate.
- Depending on the structure, these transactions “can get you as much as 50% to 100% equity credit at prices that are competitive to what you could get the public market for similarly sized hybrids; but you can also do these things in a much more tailored way that could be more efficient from an after-tax cost of capital and execution perspective,” Mr. Fratepietro said.
- He added, “High-equity content gives a company the unique opportunity to de-capitalize a business and redeploy that capital in more efficient ways. Which is particularly useful in a higher cost of capital environment.”
- He noted that companies that sell a business outright or issue common stock to raise capital sacrifice upside and incur a cost of capital exceeding 10%. “So assuming you don’t want to give up upside and you want something with a more fixed income-like cost, the challenge is that the depth and flexibility in public markets can be somewhat limited. It’s hard to get two, three, four, five billion out of the public market and do anything with unusual features, so this may provide a superior path.”
Best practices, banks and boundaries. Mr. Fratepietro underscored the importance of treasury playing an active role in any deals trying to access this pool of capital, noting that M&A or corporate development teams may assume they’re in charge because large PE players like Apollo are involved.
- “These deals have a real capital markets nexus when you really boil them down to the nuts and bolts,” he said. “The execution tactics and structuring may be M&A-like in the case of a JV transaction, but other aspects like ratings treatment, pricing and comparison to alternatives require treasury input. I have seen deals where treasury got involved later and that doesn’t help.”
- He recommends defining objectives and exploring solutions before engaging with a PE firm. Also, bring in tax, accounting and legal experts early in the process. He stressed the need to set ground rules with the firms and establish boundaries for engagement. Because PE firms are used to dealing with smaller companies, they may end up calling the CFO or CEO, creating inefficiency and headaches for treasury.
- Finally, one reason to engage a bank to advise on the process is the benefit of considering different PE firms, Mr. Fratepietro said. “If you’re going to do something like this, it’s important to engage multiple firms and actually try to run a bit of an auction for the instrument you want to sell.”