For all the strides sponsored companies have made in refinancing billions of dollars of debt, recent in- and out-of-court restructurings -- including that of Keystone Automotive Operations Inc. -- reveal some rough patches for the middle market. The slow economic recovery and skittish credit markets have sharpened contrasts between stronger portfolio companies whose revenues and valuations have rebounded and those that have been dragged down by weak markets or debt strains, or both.

"While financial markets are pretty friendly with good-sized companies, midmarket companies struggle a bit if they're facing liquidity challenges or lenders have concluded that they're not going to be flexible going forward," says Peter Fitzsimmons, AlixPartners LLP's president, North America.

At the beginning of April, majority owner Bain Capital LLC handed the keys of portfolio company Keystone to private equity brethren Platinum Equity LLC and prior owner Littlejohn & Co. LLC.

The recapitalization, completed in late March, enabled Platinum and Littlejohn to assume just over 50% and 20% of equity, respectively, via a debt-for-equity swap. Other bondholders, including certain Keystone managers, also converted debt to equity and acquired additional common stock through a rights offering, a source says.

Platinum grabbed the largest chunk of Keystone's junk bonds cheaply; so did Littlejohn, which had tracked the company even after handing it off to Boston-based Bain in 2003 in a $441 million secondary buyout. Bain invested most of the $179 million of equity that was wiped out. Littlejohn's co-investors, Advent International Corp. and GE Capital Corp., rolled over some equity that also evaporated.

Keystone had been a lucrative investment for the previous owners, who booked a combined profit of more than $180 million from the Bain sale.

And, at least for a time, it fared well under Bain, boosting top-line growth with acquisitions and expanding geographically. Despite adding scale, it fell into a slump, recording five consecutive years of net losses starting in 2006.

In October the company felt compelled to consider restructuring, conceding "its high degree of leverage" -- about $390 million at the time, coming due over the succeeding three years. Its debt-to-Ebitda ratio hovered at a staggering 14 times, ratings agencies say.

As a wholesaler and retailer of custom exhaust systems, roof racks, grill guards, suspension kits and other accessories, Keystone hadn't benefited from the turnaround in car sales as other private equity-backed suppliers, such as air bag maker TRW Automotive Holdings Corp. and die-cast and truck-frames producer Tower International Inc. The ripple effects of last month's earthquake in Japan won't help.

Keystone's declining revenue did begin to show some reversal last year. But its products are highly discretionary items, and demand for them is partially linked to demand for new light-vehicle sales, which as of a year ago remained at low levels, Standard & Poor's analysts Brian Milligan and Jerry Phelan say. While leverage is less, it remains high, at roughly 8 to 9 times Ebitda.

"The industry is tough for them right now, given what's happening with fuel prices," says Milligan. "The restructuring will be beneficial, but they really need an economic recovery."

Calls to Keystone and private equity executives were not returned. Littlejohn declined comment.

The complexity of many of these debt restructurings itself is a hurdle. "Most companies are overleveraged, and many have multiple tranches of collateralized debt," says Fitzsimmons, "so their capital structures are already very complex, which makes it tougher to get new money in restructuring."

Two other PE-backed companies succumbed to debt pressures: Italian restaurant chain Sbarro Inc., a Melville, N.Y., portfolio company of New York PE firm MidOcean Partners, and gourmet food retailer Harry & David Holdings Inc., controlled by Wasserstein & Co., both filed. Lenders opted for prepackaged bankruptcy filings presumably premised on a short stay in court. (The Deal LLC is owned by a private equity fund sponsored by Wasserstein & Co.)

Sbarro was on its third forbearance pact while ironing out a prepack, filed April 4. MidOcean stands to lose its original investment of $120 million. MidOcean acquired Sbarro for $450 million in 2006 at roughly 9.2 times Ebitda. As a second-lien lender, MidOcean will get a pro-rata share of new equity through the reorganization, and may get a second crack at revitalizing the chain.

Fitzsimmons cites the retail, restaurant and other consumer-based sectors as industries that continue to be under pressure. For one, specialty catalogs publisher Sheridan Group Inc., a Hunt Valley, Md., business controlled by private equity firms Bruckmann, Rosser, Sherrill & Co. LLC and Jefferies Capital Partners, has net sales of about $266 million, operating income of $9.4 million and a loss of $5.9 million, while trying to service about $143 million of debt. With weak cash flow prospects, it will rely on the goodwill of creditors to stay afloat.

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