For the last few months this blog's authors have stated deep concerns about the good possibility of a downturn in the LBO market in the near future. What everyone has seen in the tumbling housing market, and subsequently in the mortgage-backed securities meltdown, could be replicated in the leveraged buyout debt market. The Wall Street Journal and Barron's ran stories this week about how paper tied to businesses buried under LBO debt is selling at steep discounts in light of an economic slowdown or recession.
"Many LBO-linked senior loans are trading for as low as 90 cents on the dollar," the Journal reports. This does not bode well for private equity fund investors who may see their returns dry up in the coming months as portfolio companies struggle just to pay off interest on their debt. For instance, Apollo-owned Realogy, its "annual cash flow, which topped $1 billion in 2005, could drop to $700 million this year, meaning the company is barely covering its interest costs of $650 million. Next year could be even worse," reports Barron's.
The Journal's punch line: "Of course, private-equity firms have the luxury of waiting out bad markets, and the terms of their debt packages were excessively forgiving. It's a long stretch to say that overpaying for a company leads to bankruptcy. But it can destroy the lifeblood of the private-equity industry: returns. 'Their returns are less likely to be double digit,' said Jake Newman, a media analyst at research firm CreditSights Ltd. 'They won't be able to get out [of investments] as soon as they want. And there will be some that fail.'"
Some of the currently souring LBO deals both publications report on include:
Univision's first-lien paper is trading at 91.6 cents of par
Freescale Semiconductor's term loan is changing hands at 93.2 cents
Realogy's 10 1/2% senior unsecured notes due in 2014 trade around 75 cents on the dollar and yield 17%, while the 12 1/2% subordinated notes due in 2015 trade for 62 and yield 23%. They were issued at about 98
Linens 'n Things' debt now trades at about 55 cents on the dollar
Swift Transportation 12 1/2% bonds were fetching just 52 cents on the dollar last week, for a 26% yield to maturity
Bonds issued by Columbia Sussex (which acquired casino operator Aztar) were trading last week at 68 cents on the dollar, to yield 17%
Claire's Stores subordinated 10 1/2% bonds of 2017 trade for 62, for a 19% yield
Dollar General's subordinated 11 7/8% debt due in 2017 has fallen to about 80 from par of 100 when it was sold in late June, and now yields 16%.
For vulture funds and some hedge funds, I'm sure they will be making unusually small loans to ailing private businesses, who are desperate for cash infusions, in order to monitor their financial health. When the timing is right, these funds will swoop in and pick apart the carcasses.