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* Getty bonds go from above par to 75 cents on the dollar in5 months
* Leverage in private equity deals rising
* Record junk bond issuance may hide other risky deals
By Greg Roumeliotis
NEW YORK, Oct 17 (Reuters) - When private equity firmCarlyle Group LP bought a controlling stake in GettyImages Inc in October last year, debt investors fell over oneanother to help finance the $3.3 billion deal.
Carlyle raised about $2.6 billion in bank loans and bonds.At a time when benchmark 10-year Treasury debt yielded 1.7percent, thanks to the U.S. Federal Reserve's policy of keepingrates at record lows, the bonds' 7 percent coupon wasirresistible to many investors. For most of the next sevenmonths, Getty's bonds traded above par on strong investordemand, reaching a high of almost 105 cents on the dollar inMay.
The bet is no longer looking as good. The global photoagency has been struggling to compete against startups in thelower end of the market, where Getty cannot charge a premium itdoes for iconic and rare images, such as Marilyn Monroe sportinga polka dot bikini. In particular, sources familiar with thesituation said Carlyle underestimated startup Shutterstock Inc, which has aggressively taken market share when itcomes to selling stock images to websites and smallerbusinesses. The segment accounts for about a third of Getty's$900 million in revenue.
"It's not something that has happened just in the last fewmonths, but I think it has become a realization now. Getty issecure in the high-end licensed space, nobody is there to unseatthem," said RBC Capital Markets analyst Andre Sequin. But in thelower end of the market, "Shutterstock really seems to bepulling away from the competition."
Over the summer, it became apparent to analysts that Gettywould miss its 2013 earnings projections. The value of Getty'sbonds plunged, falling as low as 75 cents on the dollar thismonth, according to Thomson Reuters data, and leaving investorswho bought the debt issue facing big losses.
Carlyle and Shutterstock declined to comment for this story,while Getty Images representatives did not respond to requestsfor comment.
Reuters News, part of Thomson Reuters Corp,competes with Getty in the market for editorial images, whichaccounts for about a quarter of Getty's revenues.
It is still early in Carlyle's investment horizon. Carlylehas plenty of time to try to reverse Getty's fortunes, asprivate equity firms typically invest in companies for three toseven years before selling them or floating them in the stockmarket through an initial public offering.
"Getty is still a business-to-business company and the majorcustomers of Getty are the Madison Avenue advertising agencies.If someone is going to be doing things for WPP Plc andOmnicom Group Inc that are looking for exclusivephotographs, Getty is one of those players," said Moody'sInvestors Service Inc senior analyst Carl Salas.
Still, private equity industry and banking sources said sucha sudden drop in the value of the debt of a portfolio company israre and illustrates how the Fed's low rate policy and thesearch for returns lulled many investors into underestimatingthe risks of buying some kinds of junk bonds.
More such setbacks could be in store for investors.Issuance of junk bonds hit a record $255.8 billion in the UnitedStates in the first nine months of the year, up 10 percent froma year ago, according to Thomson Reuters data. Last month sawthe most prolific issuance of high-yield bonds in history.
Further, leverage in private equity deals - which measuresdebt as a factor of a company's cash flow and hence its abilityto service the obligations - has risen steadily since thefinancial crisis, averaging 6.2 times earnings before interest,tax, depreciation and amortization (EBITDA) so far this year, upfrom 5.3 times in 2012 and 4.7 times in 2011, according tomarket research firm Pitchbook.
"The debt multiples are definitely going up and you canfind yourself in the same kind of situations that happenedbefore the 2007-2008 bubble," said Kelly DePonte, managingdirector at private equity advisory firm Probitas Partners LLC.
GETTY SNAPSHOT
Carlyle's investment in Getty, which came the same month asShutterstock's initial public offering last year, was driven bythe growth in digital media, as more websites and other mediabusinesses require images and other media content.
In October 2012, Carlyle bought 51 percent of Getty fromHellman & Friedman LLC, another private equity firm, which hadtaken the company private in 2008 for $2.4 billion. Getty'sco-founder and chairman, Mark Getty, and his family rolled intheir stake as part of the deal.
To fund the deal, Carlyle arranged a $1.9 billion loan -which is now trading at around 90 cents on the dollar - from aconsortium of banks led by Barclays Plc, as well asissued $550 million in bonds, which were snapped up by majorfund managers, including Pacific Investment Management Co,AllianceBernstein Holding LP and BlackRock Inc.
As a result, Getty's leverage, by one measure, jumped to 7.1times EBITDA from 4.6 times, according to Standard & Poor'sRatings Services. This added $850 million to the company's debtpile, according to Moody's. As is the case with many leveragedbuyouts, both credit agencies downgraded the rating of Getty'sdebt.
Barclays and BlackRock declined to comment, while PacificInvestment Management and AllianceBernstein did not respond torequests for comment.
