Market's Jitters Stir Some Fears For Buyout Boom [WSJ]
Takeover-Related DebtnGets Chilly Reception;
Hearing 'Wake-Up Call'
By SERENA NG, TOM LAURICELLA and MICHAEL ANEIRO
June 28, 2007; Page A1
As several debt offerings faced resistance yesterday, bankers and investors began to wonder whether the tremors coursing through the nation's debt markets signaled that the buyout boom is in jeopardy or just suffering a temporary setback.
Much of the recent record wave of takeovers has been built on borrowed money, fueled by easy credit terms and low interest rates. But on Tuesday, investors rejected a $3.6 billion buyout-related bond-and-loan deal by U.S. Foodservice Inc., the nation's second-largest food distributor, which subsequently pulled the bond offering and postponed plans to sell the loans.
That left underwriters of U.S. Foodservice, which is being acquired for $7.2 billion by private-equity firms Kohlberg Kravis Roberts & Co. and Clayton, Dubilier & Rice Inc., holding the debt on their own books, something the Wall Street firms wanted to avoid.
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There wasn't any similar-sized stumble yesterday. But Catalyst Paper Corp., citing "adverse" market conditions, scrapped a $200 million offering of junk bonds the Canadian company planned to use for funding its business and other investments or acquisitions.
Meanwhile, underwriters delayed the launch of a buyout-financing deal for Myers Industries Inc. in the hope that the market would settle down in coming days. Late in the day, Magnum Coal Co. became the latest company to postpone a junk-bond offering, this one for $350 million.
In Europe, Arcelor Finance, the borrowing vehicle for Arcelor SA, which is being acquired by Mittal Steel Co., put off its plans to issue more than €1 billion ($1.34 billion) in bonds, citing the turbulent debt market. In Malaysia, shipping company MISC Bhd. put plans for a $750 million bond offering on the back burner.
In another sign that investors may be developing some indigestion from the buyout boom, Blackstone Group, the buyout firm that listed shares on the New York Stock Exchange last week, fell 2.7% in 4 p.m. composite trading yesterday to $29.92, below its offer price of $31 a share.
'The Biggest Risk'
Taken together, the setbacks are stoking unease across Wall Street. "The biggest risk we face -- and there are a lot of things that contribute to this risk -- would be a very big crisis in the credit markets," Lloyd Blankfein, chief executive of Goldman Sachs Group Inc., told an audience at The Wall Street Journal's Deals & Deal Makers conference in New York. A "sentiment shift," he said, "could unravel very quickly" the vast wealth that has been created by the takeover boom.
[Lofty Heights]
At the same conference, Treasury Secretary Henry Paulson called the market jitters "a wake-up call to focus on excesses" that have developed in recent years in the debt markets.
Several factors underlie the new pushback against buyout financings. One is the growing awareness that investors have been demanding very little in return for the risk they have accumulated in snapping up buyout-related loans and debt.
Yields on junk bonds, when compared with ultrasafe U.S. Treasury securities, hit historic lows around a month ago. The near-collapse of two Bear Stearns Cos. hedge funds that invest in risky subprime-mortgage debt also sparked broader investor worries about risky investments.
Still, it isn't clear if the latest credit-market turmoil represents the kind of shift in sentiment that Mr. Blankfein and others worry about. Mr. Blankfein himself, and many others at the conference, said they expected a soft landing for the market. Underpinning that hope: The global economy remains in strong shape. Growth is robust, and inflation and interest rates are low.
And some deals are still moving forward, including debt offerings by Dollar General Corp. and ITT Switches, a unit of ITT Corp., both of which are being acquired by private-equity firms. Banks handling the Dollar General deal intend to sell investors $2.4 billion of loans and an additional $1.9 billion in junk bonds with provisions that give the company leeway if it struggles. To entice investors, the underwriters have been offering higher interest rates.
Other less-risky bond sales were completed yesterday, including a $3 billion junk-bond offering by Community Health Systems Inc., a hospital operator.
In recent years, easy credit has allowed private-equity investors to raise gobs of cash to take private such corporate giants as student lender Sallie Mae, utility TXU Corp. and hospital operator HCA Inc., transferring them from public markets into private hands. The low-interest-rate loans and bonds behind these takeovers also have increasingly given borrowers extra leeway if their operations struggled.
Last year, announced private-equity buyouts in the U.S. hit $395 billion in value, including the companies' existing debt, according to Thomson Financial. Already this year, the total has reached $308 billion.
If buyers of these loans and bonds -- typically institutional investors like mutual funds, pension funds, hedge funds and endowments -- start to turn sour on these borrowings, it could slow, if not derail, the buyout boom.
Some big buyout-related deals remain in the pipeline. Investors are looking ahead at $250 billion of new debt coming to market in the next several months. Just this week, Chrysler Group, which is being sold to Cerberus Capital Management by German parent DaimlerChrysler AG, began marketing a debt fund raising that will total more than $60 billion.
In addition to demanding higher interest rates, investors are resisting many bonds and loans whose terms they believe to be too easy on borrowers. Investors have rejected a number of recent deals that included "payment-in-kind" provisions, which allow companies to postpone debt payments to their lenders if they run short of cash. Investors also have rejected loans that are light on certain common performance requirements, known as covenants.
"A lot of managers are starting to get miffed about deals with no covenants and the fact that underwriters seem to have little regard for the risks investors are assuming," said Bradley Kane, who manages a portfolio of corporate loans at SCM Advisors LLC in San Francisco.
Banks in several cases have been stuck holding portions of loans or bonds they planned to parcel out to investors, something that could make them more selective in underwriting deals. Meanwhile, companies and their private-equity buyers face bigger drains on their cash flow as their interest costs rise.
The debt offering by U.S. Foodservice, which is being sold by Ahold NV of the Netherlands, is emblematic of the type of deal that just a month or two ago was getting snapped up, largely by hedge funds.
Tuesday evening, a group of Wall Street underwriters canceled a $1.55 billion bond offering and a $2 billion sale of corporate loans for U.S. Foodservice after failing to find enough investors to take on the debt. The underwriters had to finance the $3.6 billion in debt on their own via a "bridge" loan to the company.
On the surface, U.S. Foodservice ought to have been an attractive investment. The company, which distributes food to 250,000 restaurants, hotels and schools nationwide, provides the kind of stable cash flow that debt investors like.
Frosty Reception
The offering was handled by Citigroup Inc., Deutsche Bank AG, J.P. Morgan Chase & Co., Morgan Stanley, Goldman Sachs and RBS Greenwich. But when the underwriters began to shop the offering around two weeks ago, they met a frosty reception from analysts and portfolio managers at big mutual-fund companies and other potential buyers.
Investors were concerned about the large amount of debt U.S. Foodservice was taking on to finance the buyout. For such risky loans, they typically look for protections should the company run into trouble. One protection is collateral to seize if the company goes into default. But most of U.S. Foodservice's assets were already securing other debt obligations.
The loans in the deal also had minimal covenants, and the bonds included payment-in-kind features. Neither of those facts sat well with potential investors, who refused to buy the debt on the proposed terms.
"We didn't think investors were being compensated for the risk," said Andrew Cestone, head of the high-yield team at Evergreen Investments, a money-management arm of Wachovia Corp. Evergreen turned down the deal.
Market participants said hedge funds, which had been reliable buyers of even the most speculative offerings, were also suddenly absent from the marketplace.
It quickly became clear that the deal would struggle, participants say. U.S. Foodservice's underwriters were soon making calls to investors, asking what would make the deal more enticing. The main demands from potential buyers were structural -- get rid of the payment-in-kind feature and add in covenants. Then there were the returns being offered investors; the yields were below what fund managers thought they needed in view of the deal's risk.
But the underwriters said they couldn't budge on those terms. They also didn't cede much ground on price, and investors continued to say no thanks. Now, the offering sits on the underwriters' books. They hope to distribute the loans and bonds to investors in the months ahead. |
