Investors can forget about breathtaking profits from leveraged buyouts. The credit market’s turbulence has all but shut down that business, perhaps for quite some time, and many announced deals may also crater.
Wall Street banks are facing the worst credit conditions in years as they try to sell reluctant buyers more than $300 billion of LBO-related debt to finance private-equity takeovers. As a result, the underwriters are doing what they can to get out of deals or are trying to force the buyout firms to make concessions on the debt.
That’s why LBOs still in the pipeline shouldn’t be considered a done deal. In some cases, they seem to be far from it.
Shareholders in Reddy Ice Holdings Inc. are learning that fast. Just days ago, it looked like the packaged ice maker would be bought by GSO Capital Partners for $31.25 a share, a 10 percent premium above its stock price before the July 2 takeover bid.
Now, underwriter Morgan Stanley is trying to get out of its financing commitment. The sides are wrangling over whether Reddy and GSO had the right to amend their buyout agreement, which was changed after conditions in the debt market deteriorated without Morgan Stanley’s consent, according to a Reddy securities filing on Sept. 12.
Morgan Stanley is claiming that such a move by the buyers “disabled themselves from satisfying certain conditions to Morgan Stanley’s commitment to provide the debt financing,” according to the filing. Morgan Stanley declined further comment; Reddy didn’t return a call requesting comment.
That Morgan Stanley delved into the deal’s fine print to try to wriggle free from its financing commitment should raise a red flag about what’s to come in LBOs.
Altered State
It’s a drastic change from the first six months of this year, when the investment banks were tripping over each other to earn huge fees by underwriting LBOs and then quickly unloading the debt to institutional investors.
Now, a financial world plagued by the surge in risky borrowers defaulting on their home loans has sparked fears of a widespread credit crisis and largely paralyzed dealings in debt markets.
What’s more, LBO loans that made it to market before the credit collapse are now being battered, so underwriters don’t have much to show for their past work.
Since May 1, the average price in a sample of 15 LBO bond issues with 21 pieces has dropped to 90.01 cents, a decline of 8.78 points in principal. Investors in those issues on average have lost 2.41 points of principal more than the market average, according to Standard & Poor’s Leveraged Commentary and Data Group.
For example, Claire’s Stores’ senior pay-in-kind toggle notes due in 2015 — which allows the company to cover its interest costs by issuing additional bonds rather than paying cash — now trade around 83 cents on the dollar, S&P said. That’s a 17 percent haircut since they were originally sold in late May.
Dollar General’s notes, also due in 2015, sold for 98.03 cents on the dollar in late June but now trade around 91.5 cents. OSI Restaurant Partners’ loans have fallen 13 percent since their early June debut to now trade around 87 cents, according to S&P.
Given the dismal state of affairs, underwriters are scrambling to piece deals together. They are asking private-equity firms to make concessions on the debt that was committed, which would give investors better protection in case of default.
Piecemeal
Consider what’s gone on in the financing for the $26 billion buyout of First Data Corp., the most closely watched loan deal of the year given the size of the debt and the solid reputation of the data processor.
Buyout shop Kohlberg Kravis Roberts & Co. has finally agreed to some changes in its loans after weeks of huddled discussions with its banks, including lead arrangers Credit Suisse and Citigroup.
Instead of a $14 billion loan being brought to market at once, it has been downsized to $13 billion and will be sold in pieces over the coming months. The first will total only $5 billion, and the arrangers have the right to sell another $3 billion by year end, according to CreditSights.
