This week, a Blackstone-led consortium of lenders, including Apollo and KKR, took ownership of Medallia, a software company that Thoma Bravo acquired in 2021 for $6.4 billion. Thoma Bravo's $5 billion equity contribution has been entirely wiped out, marking one of the largest losses in private equity history, second only to the collapse of Texas utility TXU. This transfer occurred because Medallia's debt became unsustainable, prompting Thoma Bravo to hand the company over to its creditors rather than inject more capital.
This event significantly shifts private credit, which was once seen as a low-risk, high-return venture by figures like Blackstone CEO Steve Schwarzman, into a private equity problem. Lenders, who initially expected to be passive "coupon clippers" receiving a reliable stream of interest payments, are now forced to become actively involved in running the companies they financed. While Blackstone, with its extensive experience in buying and improving businesses, is better equipped for this transition, many other private credit lenders in the burgeoning $2 trillion market may lack the necessary turnaround or restructuring skills.
Medallia's debt load, once considered conservative, looked attractive when Thoma Bravo bought it at what was likely the market's peak. Subsequent interest rate hikes in 2022 caused the company's interest expenses to balloon. Lenders have since had to mark down their loans to 60 or 70 cents on the dollar. Fitch estimates private credit default rates have reached an unprecedented 6%, suggesting more such scenarios are likely. The debt on Medallia’s balance sheet increased by over $1 billion after Thoma Bravo’s takeover, partly due to acquisitions and additional borrowing to cover interest payments.
Despite the challenges, this situation also highlights a potential advantage of the private credit boom: the ability of a club of elite lenders to resolve distress more quickly than in traditional, messy Chapter 11 bankruptcy proceedings. A private credit restructuring offers a faster and cheaper alternative. However, it underscores that the promise of a 12% return with minimal prospect of loss, once touted by some, is proving to be far more complicated and less certain than initially expected. Private credit companies had rapidly financed software groups backed by private equity, especially during the early 2020s when valuations were high, leading to current anxieties among investors and redemptions from some funds.
Lenders will inject an additional $150 million into Medallia to help reduce its debt. They believe this new capital structure will stabilize the company and that its core business performance is adequate. Orlando Bravo, co-founder of Thoma Bravo, publicly admitted that the firm "overpaid" for Medallia, citing that they moved too quickly during the 2021 deal environment and that the anticipated growth did not materialize. The rise of AI tools also poses potential complications for many software deals from that era by disrupting existing business models.
