Debt market squeezing Private Equity

By MICHAEL J. de la MERCED
Published: July 21, 2007
After two years of rapid-fire deal making, private equity firms are finding it harder to get the job done.
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Debt Troubles

Some 15 to 20 debt offerings — analysts’ estimates vary — have been modified or postponed as anxious investors have demanded better terms for high-yield loans and bonds, the lifeblood of the leveraged buyout. Private equity firms have had to raise interest rates and sweeten the repayment — or risk having to withdraw the offerings entirely.
“It’s the issuers who are over a barrel right now,” said Justin B. Monteith, an analyst with the research firm KDP Investment Advisors. “The market could go lower as people see how far they can push the issuers.”
Anxiety over securities backed by risky mortgage loans and rising interest rates has roiled the credit markets for several months. Now the contagion from those troubles seems to be spreading into other parts of the marketplace. After edging past the 14,000 mark on Thursday, the Dow Jones industrial average closed yesterday at 13,851.08, down 149.33 points, in part because of continued concern about subprime mortgages.
The yields on 10-year Treasury notes fell below 5 percent yesterday, closing at 4.95 percent, in another sign that investors are looking for safe havens.
This week, the sale of loans meant to finance the buyouts of the Chrysler Group and the European retailers Alliance Boots and Maxeda have been sweetened or postponed. Bond sales have not fared much better: about $3.65 billion in offerings have been postponed since June 26, according to data from KDP.
If conditions do not improve, private equity firms and their bankers may face an even uglier situation. Some $235 billion in loans are waiting to be sold, nearly all for leveraged buyouts, according to Standard & Poor’s Leveraged Commentary and Data.
Nearly all major debt offerings that were expected to take place next month have been pushed back. First Data, a credit card processor whose $22 billion sale of loans and bonds is widely seen as a bellwether for the high-yield credit markets, has pushed back its offering until after Labor Day. Bankers for other major buyouts, like TXU’s, may hold off their debt sales even longer.
In short order, one of the friendliest environments that private equity firms have seen in years has quickly grown hostile. Once they could command extraordinarily lenient terms from investors, making the debt used to fuel leveraged buyouts quite cheap. So-called covenant-lite loans, which have few restrictions on repayment, blossomed, as did pay-in-kind toggles, bonds that could be repaid by issuing more debt.
Now, analysts say, investors have shunned that easy debt, forcing buyout firms to pay more to get their deals done.
This week, Chrysler raised the interest rates on $18 billion in loans meant to finance its buyout by Cerberus Capital Management, a private equity and hedge fund firm, Mr. Monteith said. The two sets of loans, earmarked for the carmaker itself and for its financing unit, may now cost the company millions more in interest payments.
Two companies being acquired by the private equity giant Kohlberg Kravis Roberts also postponed debt offerings amid the tougher market conditions. Alliance Boots, a British pharmacy chain, reportedly delayed £9 billion (or $18.5 billion) in loans. The chain is also said to be considering raising the interest rates on those loans.
And Maxeda, a Dutch department store retailer, also canceled an offering of 1 billion euros ($1.4 billion). It is not clear when either company will reschedule those sales.
The troubles in the loan market have followed similar struggles to sell high-yield bonds. Over the last month, companies like U.S. Foodservice, a major provider of food to restaurants and school cafeterias, and ServiceMaster International, a lawn care and pest control services provider, have had to cancel bond offerings totaling almost $2 billion.
To sell $1.175 billion in bonds to finance its buyout last month, Dollar General removed an additional $725 million in toggles.
Buyout firms are not the only ones suffering from the growing wave of caution sweeping through the markets. An increasingly popular practice among banks has been to assume part of the equity of these deals in what is known as an equity bridge. Banks normally turn around and sell off these portions to other investors. But at least two times over the past month, in the deals for U.S. Foodservice and ServiceMaster, banks have been stuck on the bridge.
“I hope they go the way of the dinosaur,” James Dimon, JPMorgan Chase’s chief executive, said in a conference call on Thursday.
Mr. Dimon has reason to sound alarmed. His bank is providing a $500 million bridge for TXU’s buyout by Kohlberg Kravis and TPG Capital; Bank of America and Citigroup are also providing $500 million each.
Later on in the call, Mr. Dimon sounded less worried. “There are some hung bridges, again nothing on our balance sheet we are particularly concerned about,” he said. But the consequences of being stuck on a bridge are serious. The more banks’ hands are tied with these loans, the less money they have to make additional loans to other deals.
One private equity firm that is particularly at risk if credit starts to dry up is Kohlberg Kravis. It is exposed to at least six deals that have been delayed, modified or canceled in the last month. The firm filed to go public earlier this month.
The tighter credit markets may not choke off deal making. But, analysts say, private equity must be willing to pay a higher price.