Credit crunch likely to slow LBOs
The great leveraged-buyout boom of recent years - in which private-equity firms teamed up with banks to finance hundreds of billions of dollars worth of acquisitions - appears to be over, a victim of the credit crunch paralyzing Wall Street.
But while the frenzy for leveraged buyouts has dropped dramatically from the record-setting levels of 2006 and the first half of 2007, experts don't think the harsh new world of higher interest rates for private-equity firms is going to scuttle the biggest deals currently in the pipeline. Instead, they warn that such deals are likely to be renegotiated in light of the lack of liquidity in the marketplace.
Home Depot was just forced to cut the price of its wholesale supply unit from $10.3 billion to $8.5 billion, the Associated Press reported, citing an unnamed person with direct knowledge of the situation. Among the reasons cited: the buyers, a consortium of private equity firms including Bain Capital, Carlyle Group and Clayton Dubilier & Rice, were going to have to pay a much higher interest rate for the money they borrowed to close the deal.
Watch for a similar dynamic to play out among other big LBOs, says Dan Primack, editor at large of Thomson Financial's PE Hub. "Almost all of these deals are going to get done, but maybe at different terms," he says.
The sellers still want to sell their companies, Primack says. The other parties in the transactions - the private-equity firms and the banks that loan them the money - both have financial incentives to see the deals through, even if the terms are no longer as attractive as they were in early July:
- The private-equity firms, if they back out of the acquisitions they'd already agreed to, would have to pay some "pretty major break-up fees," Primack says. In the case of Home Depot, those fees would total $300 million.
_The banks that loan the money to close the deals "have some serious reputational issues here," Primack adds. If a major bank pulls out of a deal, it could damage its reputation in the lucrative field of mergers and acquisitions. What CEO would want to choose as an M&A adviser a bank with a history of cutting and running in adverse conditions?
Other major leveraged buyouts announced earlier this year, including Hilton Hotels, First Data and Canadian telecom BCE, are likely to go through, Primack says. The only two deals that might fall apart would be the buyouts of Sallie Mae and TXU, both of which have run into regulatory problems, he says.
While private equity firms are going to have a much more difficult time profiting from buyouts, there will be some winners in a shake-out, says Christopher Whalen of Institutional Risk Analytics: Big institutional investors will be able to negotiate higher rates when they help finance takeovers. "When a bank calls you and asks you if you want to buy into the debt from these deals, say no and slam the phone down. I guarantee you the phone will ring again. You can demand more."
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