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Insight: Getty captures risks of Fed's easy money policy

By Greg Roumeliotis

NEW YORK (Reuters) - When private equity firm Carlyle Group LP bought a controlling stake in Getty Images Inc in October last year, debt investors fell over one another 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 1.7 percent, thanks to the U.S. Federal Reserve's policy of keeping rates at record lows, the bonds' 7 percent coupon was irresistible to many investors. For most of the next seven months, Getty's bonds traded above par on strong investor demand, reaching a high of almost 105 cents on the dollar in May.

The bet is no longer looking as good. The global photo agency has been struggling to compete against startups in the lower end of the market, where Getty cannot charge a premium it does for iconic and rare images, such as Marilyn Monroe sporting a polka dot bikini. In particular, sources familiar with the situation said Carlyle underestimated startup Shutterstock Inc , which has aggressively taken market share when it comes to selling stock images to websites and smaller businesses. 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 few months, but I think it has become a realization now. Getty is secure in the high-end licensed space, nobody is there to unseat them," said RBC Capital Markets analyst Andre Sequin. But in the lower end of the market, "Shutterstock really seems to be pulling away from the competition."

Over the summer, it became apparent to analysts that Getty would miss its 2013 earnings projections. The value of Getty's bonds plunged, falling as low as 75 cents on the dollar this month, according to Thomson Reuters data, and leaving investors who bought the debt issue facing big losses.

Carlyle and Shutterstock declined to comment for this story, while Getty Images representatives did not respond to requests for comment.

Reuters News, part of Thomson Reuters Corp , competes with Getty in the market for editorial images, which accounts for about a quarter of Getty's revenues.

It is still early in Carlyle's investment horizon. Carlyle has plenty of time to try to reverse Getty's fortunes, as private equity firms typically invest in companies for three to seven years before selling them or floating them in the stock market through an initial public offering.

"Getty is still a business-to-business company and the major customers of Getty are the Madison Avenue advertising agencies. If someone is going to be doing things for WPP Plc and Omnicom Group Inc that are looking for exclusive photographs, Getty is one of those players," said Moody's Investors Service Inc senior analyst Carl Salas.

Still, private equity industry and banking sources said such a sudden drop in the value of the debt of a portfolio company is rare and illustrates how the Fed's low rate policy and the search for returns lulled many investors into underestimating the 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 United States in the first nine months of the year, up 10 percent from a year ago, according to Thomson Reuters data. Last month saw the most prolific issuance of high-yield bonds in history.

Further, leverage in private equity deals - which measures debt as a factor of a company's cash flow and hence its ability to service the obligations - has risen steadily since the financial crisis, averaging 6.2 times earnings before interest, tax, depreciation and amortization (EBITDA) so far this year, up from 5.3 times in 2012 and 4.7 times in 2011, according to market research firm Pitchbook.

"The debt multiples are definitely going up and you can find yourself in the same kind of situations that happened before the 2007-2008 bubble," said Kelly DePonte, managing director at private equity advisory firm Probitas Partners LLC.

GETTY SNAPSHOT

Carlyle's investment in Getty, which came the same month as Shutterstock's initial public offering last year, was driven by the growth in digital media, as more websites and other media businesses require images and other media content.

In October 2012, Carlyle bought 51 percent of Getty from Hellman & Friedman LLC, another private equity firm, which had taken the company private in 2008 for $2.4 billion. Getty's co-founder and chairman, Mark Getty, and his family rolled in their 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 a consortium of banks led by Barclays Plc , as well as issued $550 million in bonds, which were snapped up by major fund managers, including Pacific Investment Management Co, AllianceBernstein Holding LP and BlackRock Inc .

As a result, Getty's leverage, by one measure, jumped to 7.1 times EBITDA from 4.6 times, according to Standard & Poor's Ratings Services. This added $850 million to the company's debt pile, according to Moody's. As is the case with many leveraged buyouts, both credit agencies downgraded the rating of Getty's debt.

Barclays and BlackRock declined to comment, while Pacific Investment Management and AllianceBernstein did not respond to requests for comment.

(Additional reporting by Soyoung Kim, Rachelle Kakouris and Lisa Lee in New York; Editing by Paritosh Bansal, Martin Howell and Ken Wills)

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