So who are the parties benefited most from the Fed stop raising interest rate? The answer is hedge funds that doing LBO (Leveraged buy out)
Gap, Tribune, R.R. Donnelley Derivatives Show Growing LBO Risk
By Hamish Risk
Aug. 28 (Bloomberg) -- The likelihood that Gap Inc., R.R. Donnelley & Sons Co. and Tribune Co. and more than a dozen other U.S. companies will pile on debt in leveraged buyouts is increasing, according to Bank of America Corp.
Research by the nation's second-largest bank shows that the perceived risk of owning bonds sold by these companies has jumped an average 41 percent this year to the highest ever. Bank of America based its finding on prices of credit-default swaps, financial instruments linked to corporate bonds and loans that are used to speculate on increasing or decreasing indebtedness.
Investors are growing more concerned about the threat of leveraged buyouts because prices of bonds issued by companies that have been taken over have tumbled as much as 14 percent. Private equity firms raised $132 billion so this year for acquisitions. The companies most at risk for LBOs tend to have falling stock prices, low debt and stable revenue.
``Risk is likely to accelerate in coming months due to the pressure on private equity firms to utilize the funds raised,'' said Raja Visweswaran, a credit strategist at Bank of America in London. ``Investors should prepare for downside surprises.''
Credit-default swaps, the fastest growing derivatives market, have become the best gauge of shifts in credit quality. The market has grown seventeen fold in five years to $346 billion, according to the International Swaps and Derivatives Association. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.
Growing Risk
The $33 billion takeover in July of HCA Inc., the biggest U.S. hospital operator, underscored potential bondholder losses. The Nashville, Tennessee-based company's $9.2 billion of bonds lost on average 9.85 percent last month, including reinvested interest, according to data compiled by Merrill Lynch & Co. The price of HCA's $1 billion 6.5 percent notes due in 2016 have plunged 14 percent since the announcement of the LBO.
``It was a potent reminder that LBO risk is out there,'' said John Tierney, credit strategist at Deutsche Bank AG in New York. ``They have the wherewithal to go after something really big.''
Those risks are now showing up in the credit-default swaps of companies such as R.R. Donnelley, the Chicago-based printer of Sports Illustrated magazine. The perception of the company's creditworthiness fell the most among the 19 companies in the Aug. 21 Bank of America report. The companies have more than $40 billion in debt. They have no control over credit-default swaps because the contracts are created and traded by financial firms.
Takeover Offers
The price of the contracts on Donnelley debt jumped almost fivefold in the past month to $240,000 from $50,000. An increase suggests perceptions of credit quality are declining. The contract would pay an investor $10 million in the event of default within five years.
Donnelley may get takeover offers from two competing buyout firms, people briefed on the matter said last week. Its shares reached a two-year low on July 27 on investor concern that digital media is taking market share from print publications.
Credit-default swaps related to Chicago-based Tribune, the second biggest U.S. newspaper publisher, have more than tripled since May to about $135,000. Tribune's stock reached an eight- year low earlier this year as advertising revenue dropped.
Contracts based on the bonds of San Francisco-based Gap have jumped to $106,000, from $80,000 this year as sales at the largest U.S. clothing company fell in 23 of the past 26 months.
Donnelley spokesman Doug Fitzgerald didn't return two calls seeking comment. Tribune spokesman Jeff Reiter declined to comment. ``We as a matter of policy don't speculate on rumors,'' Gap spokesman Greg Rossiter said.
No Buyers
Many takeover targets are never acquired. Donnelley's talks may have stalled after it failed to receive bids for the amount it sought, Crain's Chicago Business reported Aug. 25, citing unnamed people familiar with the negotiations.
``Private equity is saying even with all this money flowing in, we won't pay the wrong price,'' said Bradley Rogoff, a credit strategist at Lehman Brothers Holding Inc. in New York.
Companies that have failed to find a buyer this year, include El Segundo, California-based Computer Sciences Corp. and Jones Apparel Group Inc., the Bristol, Pennsylvania-based maker of Jones New York clothing and Nine West shoes.
``Of the potential LBOs we've looked at, about a third of those have worked out,'' said Graham Neilson, a fund manager at Credaris Portfolio Management in London, who helps oversee $1.3 billion of bonds and derivatives.
Growing Risk
The perception of corporate credit quality for U.S. companies has been improving. The Dow Jones CDX index of credit- default swaps, based on 125 investment-grade companies in North America, fell to $38,840 from $46,180 at the end of 2005, according to data compiled by Bloomberg. The index includes derivatives based on debt sold by Camden, New Jersey-based Campbell Soup Co. and Deere & Co. in Moline, Illinois. The companies have more than $2 trillion of bonds outstanding.
The risk is growing that LBOs will ``pick up over the coming weeks,'' Barclays Capital analysts led by Mark Howard in New York said in a research report on Aug. 21.
Buyout firms have announced $317 billion of takeovers this year, surpassing the 2005 total by 15 percent, according to data compiled by Bloomberg. Henry Kravis, co-founder of New York-based Kohlberg Kravis Roberts & Co., part of the group that acquired HCA, told investors on a conference call on Aug. 17 that he's ``never seen'' so much capital available for deals.
Credit-default swaps on HCA's debt soared as high as $450,000 this month from about $155,000 in July. Moody's Investors Service, Standard & Poor's and Fitch Ratings have all said they may downgrade the company.
``The risk versus the reward of LBOs still looks very attractive,'' said Neilson at Credaris.
To contact the reporter on this story: Hamish Risk in London hrisk@bloomberg.net
Last Updated: August 28, 2006 00:09 EDT
bloomberg.com |
