The End of the Cheap Money Era Catches Up to Chelsea FC’s Owner
The Californian private equity firm has at least $10 billion in distressed debt among its portfolio companies, a snapshot of the difficulties the buyout industry is facing right now.
A Chelsea flag at Stamford Bridge.
Photographer: Andrew Kearns/CameraSport/Getty Images
Clearlake Capital Group is best known beyond financial circles for owning Chelsea Football Club, an English Premier League team that’s been criticized at times for buying unproven players at sky-high prices.
As the California-based private equity firm raises money for its latest fund, some investors and creditors are asking similar questions about the value of acquisitions it made at the height of the buyout boom.
Back in 2020, Clearlake was turning away people clamoring to get into its sixth flagship fund. The firm had delivered in the past, dishing out best-in-class returns to its limited partners — the pensions, insurers and others who back its wagers. Companies bought from its previous cash hoards such as healthcare software company Provation and self-storage supplier Janus International were well on their way to generating stellar profits for Clearlake and its LPs.
But only a few years on from raising more than $7 billion for fund six, the world is very different. The firm used that fresh influx of investor dollars to carry on spending at the start of the decade, snapping up businesses when valuation multiples were high and piling them up with debt. Today stubbornly elevated interest rates are weighing heavily on many such assets.
Clearlake isn’t alone in having to navigate the end of the cheap money era; many of its buyout industry peers are facing the same difficulties. Investors are still signing on in droves to its latest $15 billion fundraising, pointing to its money-spinning track record in previous funds.
And yet the firm does offer a snapshot of the challenges confronting private equity right now, especially anyone who spent big between 2020 and 2022. It’s the PE firm with the most distressed debt among its portfolio companies, at least $10 billion, according to data compiled by Bloomberg at the end of June. The data captures loans trading below 80 cents on the dollar and bonds with both prices below 80 and spreads wider than 10 percentage points.
“A peak like 2021 is going to make for a poor vintage when you want to realize value,” says Christina Padgett, associate managing director at Moody’s Ratings, speaking about private equity acquisitions in general.
Clearlake's Stressed Credits
Clearlake has a number of firms with debt near stressed and distressed levels
Source: Prices rounded to the nearest cent based on estimates from debt traders and Bloomberg data during the week of July 1.
Note: Some companies have co-investors alongside Clearlake. Some companies have undergone liability management exchanges that include new loans ranked above legacy loans quoted here.
Conversations with more than a dozen people familiar with Clearlake — including investors, bankers and rivals — highlight concerns about assets bought at the M&A boom’s zenith, particularly by the sixth fund.
A slew of businesses Clearlake acquired between 2020 and 2022 such as investment software maker Confluence Technologies and Quest Software Inc., an enterprise IT specialist, are under strain, and some LPs are asking whether the private equity firm’s breakneck growth left it overstretched.
Clearlake is also among the industry’s leading users of continuation vehicles — a controversial practice of selling assets to a new fund the firm manages as well — setting up five deals in the past. It’s now exploring a sixth, for digital-marketing company Constant Contact, people with knowledge of the matter say.
A spokesperson for the firm declined to comment for this story, although others with knowledge of the situation point to the progress in its latest record fundraising as evidence of investor support. Even those who are critical in private about fund six are handing Clearlake more money, expressing the hope that its financial smarts will help it navigate a tough period for buyout groups.
Like rivals, Clearlake often plays hardball with lenders to its companies during distressed situations, shielding its own LPs from much of the pain.
Glory Days
Clearlake was founded in 2006 by José E. Feliciano and Behdad Eghbali to target technology, consumer and industrial companies through traditional buyouts and distressed investments, but it really hit its stride at the end of the last decade. These were the industry’s glory days when debt was cheap, inflation low and pension funds were awash with dollars to plow into private markets. A long-running M&A boom made asset prices go up everywhere, and firms rushed back to investors as fast as they could to nab more money.
As Jay Powell’s Federal Reserve holds fire on rate cuts, the buyout gold rush is history. And LPs are short on cash to allocate, making them more demanding.
Clearlake’s investors didn’t fret too much about its rapid growth when earlier funds were giving them handsome payouts and raking in impressive multiples of invested capital, a key performance yardstick in private equity. Its fourth and fifth funds have already given LPs back more than the capital they put in and have more assets still to sell. These successes have made its lofty fees and fondness for continuation funds tolerable to most backers.
The firm’s assets have swelled to more than $80 billion thanks to an aggressive push between 2015 and 2021, when it went back to the market every couple of years or so to raise a new buyout fund, with each one roughly doubling in size.
“Clearlake would be a poster child for the excessive popularity of that particular asset class,” says Jeff Hooke, who just retired from teaching at Johns Hopkins Carey Business School. “When you have multiple funds and start a new one every couple of years, you’ve invested the money pretty quickly.”
Clearlake's Cash Haul
The private equity firm has pursued an aggressive fundraising strategy
Source: State of Connecticut
A recent due-diligence report for the State of Connecticut, whose pension plans invest in multiple Clearlake funds, found its soaring assets under management “may cause concerns of strategy drift through the lack of discipline and focus,” while acknowledging the firm’s investment team has grown in line with assets.
Connecticut’s pension consultant wrote, too, that Clearlake “historically utilized higher leverage levels in its portfolio companies, raising concerns in current market conditions.” In common with many peers, the firm didn’t hedge enough against interest-rate shifts, although it does now. It has about $15 billion in hedges on its portfolio, a person with knowledge of the matter says.
Regardless of any investor misgivings, Feliciano and Eghbali’s latest efforts to tap LPs appear to be on track. Clearlake waded into an unforgiving fundraising environment for buyout firms last year when it started gathering cash for its eighth buyout fund, telling backers that it aimed to surpass the $14 billion raised for its seventh fund, which closed in 2022.
A year on, it has nearly $10 billion of commitments toward a $15 billion goal, a person with knowledge of the situation says, and it hasn’t had to offer investors extra incentives.
Trouble Spots
As backers weigh how much they want to commit to the latest fund, some have been paying closer attention than usual to its investments of recent years, especially from the heady days of 2020 to 2022.
Plenty are having a torrid time. Confluence, bought in 2021, has been downgraded by Moody’s, who noted that its “highly levered capital structure and weak liquidity” indicates “aggressive financial strategies.”
Clearlake is also looking at combining parts of Quest and cybersecurity outfit RSA Security — two other heavily indebted software companies in fund six — into a new business and selling a stake. It previously sold a division of RSA to repay debt and used proceeds to return money to investors, irking some lenders.
FinThrive, a healthcare e-billing company acquired in 2021, is in creditor talks about an overhaul that could include a below-par debt exchange.
And trouble isn’t confined to fund six. Wheel Pros, a custom-wheels outfit acquired in 2018, did a distressed-debt swap last year to buy time. S&P Global Ratings says it’s still vulnerable to default, and investors have dumped a new loan placed as part of the swap, driving its price down to near 60 cents on the dollar. Wheel Pros was rolled into a continuation vehicle in 2021 and, according to Connecticut’s report, its internal rate of return was -20% as of Dec. 31.
Elsewhere, Pretium Packaging, a plastic-bottle maker bought in early 2020, did a debt restructuring last year that S&P viewed as a selective default.
The deal for which Clearlake is famous, Chelsea, wasn’t loved by some investors but it’s too early to judge financially. The firm had the investment marked at Dec. 31 slightly above what it paid, despite the team reporting a £90.1 million ($115 million) pretax loss last year. Football Benchmark, which provides financial data on clubs, estimates Chelsea is worth £2.8 billion, about £500 million more than what Clearlake splashed out in 2022.
Its owners hope their vast outlay on young talent will pay off ultimately and let it compete with elite rivals such as Abu Dhabi-owned Manchester City.
Patient Capital
Such calls for patience apply equally to the broader business. The nature of PE investing means sponsors like Clearlake have long time horizons to let wagers play out. They don’t have to price assets more than once a quarter, and one slam-dunk bet can offset a lot of duds. The firm remains chipper about some recently minted investments such as BetaNxt, a wealth-management fintech.
Another feature of the buyout world is how fiercely firms work to safeguard returns for themselves and their backers when refinancing distressed debt, often at lenders’ expense. Take the restructuring of Clearlake-owned Valcour Packaging, a maker of bottle caps, which recently offered more than 90 cents on the dollar to a bunch of creditors who promised to fork up new capital.
Anyone outside that group who doesn’t play ball will be pushed toward the back of the line and can trade in their debt at 60 cents. Such bruising tactics can make enemies among lenders just as you’re having to do a lot of renegotiating.
Clearlake’s muscular approach also helps it protect returns even in dire situations. A December report from Pennsylvania State Employees’ Retirement System showed that the multiple on invested capital was more than five times on Wheel Pros, the company sold on to a now struggling continuation fund. Pretium’s was more than double.
Fund six had a net IRR of 24% as of Dec. 31, according to Connecticut’s documents, and the state’s pension plan has committed $200 million to Clearlake’s eighth fund even after its due-diligence report. Other backers took a closer look at Clearlake’s recent dealmaking and reinvested too.
People familiar with Clearlake’s strategy point out that it’s also an investor in distressed assets as well as growth opportunities, which may let it take advantage of depressed prices in today’s private markets. “We’ve had relatively decent US economic growth since the pandemic,” says Padgett at Moody’s. “So there may be decent businesses with bad balance sheets.”
Still, there’s no cause for investor complacency quite yet. PE uses a metric known as the “distributed to paid-in-capital ratio” to show how much it’s returning to investors. A ratio of one means investors got their money back. Fund six was 0.1 at the year end, according to the Connecticut documents, showing how much work remains to be done to realize value from the portfolio.
When Clearlake hosted its annual meeting for LPs a few weeks back, it made a surprising choice as star speaker: former British Prime Minister Boris Johnson. Like him, the buyout industry hit a peak of popularity at the turn of the decade before falling from favor. Getting back to those heights won’t be easy.
For Padgett, this is true for PE firms on the whole — and for the funds that lend to their companies. “Both private equity and credit are going to have more meager returns than they’d originally anticipated,” she concludes.
