Hellman & Friedman and Nets: the buyout bubble's poster child

(Bloomberg Gadfly) -- To see how hard it is for private equity firms to spend the record piles of cash they've amassed, look no further than Hellman & Friedman LLC's latest deal in Europe.

Nets deal is worth

$6.4 billion

The U.S. leveraged-buyout firm is leading a group that's buying Nordic payments provider Nets A/S for 40 billion Danish kroner ($6.4 billion), including assumed net debt. If there's one transaction that could show how private equity's ambition could unravel, this is surely it.

The size, valuation and business challenges are enormous. On its own, Nets would be way too big for H&F's funds. So the buyout firm has enlisted co-investors in the form of Singapore's GIC and Finnish insurer Sampo. Nets's existing private equity owners, Advent International and Bain Capital will also keep a stake in the company.

The price is almost 15 times estimated Ebitda for 2017 -- steep. Once upon a time, private equity firms could plan to sell businesses they acquired for at least the same valuation multiple as they bought them for. H&F will know it cannot bank on doing so in this case.

What might it see that the stock market doesn't?

There's the debt: Nets's borrowings were cut to make the company palatable for shareholders. Increasing leverage should lift returns. Net debt was three times trailing Ebitda at the half year. Boosting it to six times next year's Ebitda would allow for $3 billion of leverage, cutting the equity the purchasers will have to put up to roughly $3.4 billion.

To make a 20 percent-plus internal rate of return on that over five years would require getting more than $8 billion in a future sale. Add back the debt, and that means selling for at least $11 billion.

Suppose H&F can sell at a multiple of 12 times Ebitda. It will have to grow that measure of profit to nearly $1 billion -- just over double what analysts forecast for next year.

The snag is that Nets has already had the private-equity makeover. Margins grew sharply under Advent and Bain's ownership. H&F won't find lots of easy cost cuts. Indeed, achieving such growth organically looks almost impossible, notwithstanding the huge expansion in the use of payments processing technology as cash's popularity dwindles.

The missing link looks like more global M&A. At present, Nets is narrowly focused on its local market. Globalizing its strategy would mean more debt-financed acquisitions outside Scandinavia, an approach that might have made stock market investors balk.

Shareholders who purchased the stock at the IPO will get out at a price that more of less gives them the same capital gain as if they had bought the Danish index. That's clearly not what they bought in for. Even with this takeover, Nets has been a disappointment.

It's up to H&F to prove that a private equity firm really can do something with this business for a second time. If it can't, many will say: told you so.

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

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

To contact the author of this story: Chris Hughes in London at chughes89@bloomberg.net.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net.