In the words of Gomer Pyle, "Surprise, surprise!" -g-
Bonds Becoming a Tougher Sale
Investors Finally Balk
At Prices for Risky Debt;
New Rules for LBOs
By TOM LAURICELLA and SERENA NG
June 27, 2007; Page C1
Investors issued a resounding 'No' to a leveraged-buyout debt offering yesterday, leaving banks holding the bag for more than $3 billion and raising concerns about the changing economics of the takeover boom.
It marked a sharp escalation of resistance by investors against loose borrowing terms in a series of recent buyout-related debt offerings.
Underwriters pulled a $1.55 billion bond offering by U.S. Foodservice, the nation's second-largest food distributor. The company also postponed plans to sell $2 billion in loans to fund the deal, according to people familiar with the matter. For now, the banks involved in underwriting the deal will have to lend the $3.6 billion directly to U.S. Foodservice, which is being bought from Royal Ahold NV of the Netherlands.
The move could signal tension in the Wall Street ecosystem. Banks, private-equity funds and investors have until now worked hand-in-hand to power the historic buyout binge.
The Columbia, Md., food company is being acquired by Kohlberg Kravis Roberts & Co. and Clayton, Dubilier & Rice Inc. for $7.2 billion. When the buyout firms arranged financing with their bankers -- which include Deutsche Bank AG, Citigroup Inc., J.P. Morgan Chase & Co., Morgan Stanley and several other Wall Street firms -- they included terms that demand the underwriters provide "bridge" financing if a deal can't be sold to debt investors.
"There appears to be a broader correction in the marketplace," said Clayton Dubilier spokesman Thomas Franco. "The business is performing well, we're happy with the investment, and we have access to financing we're happy to utilize."
While the banks will try to resell the loans and bonds to investors in the year ahead, the FoodService deal could reset the equilibrium of the buyout business at large, giving banks more clout in financing negotiations while also putting strains on the amount of money available for deals. One person involved in the deal described it as a "healthy correction" for an overheated market.
Big buyouts in the past few years have been fueled by bond and loan investors who have been willing to accept skimpy interest rates and easy terms on the companies borrowing from them. But in a wave of midsize debt deals that hit the market in the past week, investors have shoved deals back to underwriters, demanding better terms.
Also yesterday, ServiceMaster Co., a lawn-care and pest-maintenance provider, significantly reduced a controversial component of a planned bond offering -- known as a "payment in kind" feature -- related to its $4.8 billion buyout. In a number of recent deals, investors have rejected such provisions, which allow companies to put off debt payments to lenders if they run short of cash.
The pushback comes at a challenging moment. Investors are looking ahead at $250 billion of new debt coming to market in the coming months. Just this week, Chrysler Group, which is being sold by DaimlerChrysler AG, began marketing a debt fund raising that will total more than $60 billion.
The buyout boom has hit plenty of air pockets in the past few years and cruised right through them. But if the latest stumbles worsen, they could make it harder for deals to get done at a time when a mountain of borrowing is planned.
Investors say several factors were at work behind the latest investor pushback. First is a general rise in interest rates in the past few weeks. Yields on 10-year U.S. Treasury notes have risen to 5.102% from 4.861% during the past month. Meantime, the near-collapse of two Bear Stearns Cos. hedge funds that invest in risky subprime-mortgage debt has investors nervous more broadly about risky investments.
In several deals now, banks are finding themselves stuck holding portions of loans or bonds they planned to parcel out to investors, something that could make them more squeamish about underwriting deals. Meanwhile, companies and their private-equity buyers face bigger drains on their cash flow as their interest costs come in higher than expected.
In the case of U.S. Foodservice, investors were reluctant to accept terms on loans that would have eliminated many common performance requirements known as covenants. Issuance of such covenant-lite loans has been common this year.
"The pendulum has swung from being a very issuer- friendly market to one that is less friendly," says Paul Scanlon, head of high-yield at Putnam Investments.
Federal Reserve chairman Ben Bernanke recently expressed concerns at the risks associated with the financing of private-equity deals, including the bridge loans that banks extend. Back in 1989, a failed junk- bond deal to finance the buyout of Ohio Mattress marked one of the turning points of the 1980s buyout boom.
The case of textbook publisher Thomson Learning, a unit of Thomson Corp., is another example of how the economics of the buyout game are changing. Thomson Learning was acquired by London private-equity firm Apax Partners Worldwide and Omers Capital Partners Inc., a large Canadian pension plan.
After having trouble raising $5.6 billion through a mix of bonds and loans, Wall Street firms ended up sitting on a $540 million bridge loan that could remain on their books for months or even years. The banks in this case were able to sell $1.6 billion in bonds, though on better terms to investors.
Thomson Learning ended up increasing interest payments on the debt it could sell. It will pay $530 million in interest annually instead of the $500 million planned, says John Puchalla, an analyst at Moody's Investors Service. "It's an additional burden, and it puts more pressure on the company to perform," Mr. Puchalla adds.
Dollar General Corp., which is being bought out by KKR for $6.9 billion, is also widely expected to have to pay investors more to pull its deal through in the coming days.
"You look at these companies, and they don't generate any free cash flow, and it's hard to come up with simple scenarios where they could naturally improve from a credit perspective," says Michael McGonigle, a portfolio manager at T. Rowe Price Group.
Investors say they are particularly wary of the payment-in-kind feature, which has become common in leveraged-buyout financings in the past months. This feature allows borrowers to turn their interest payments on and off like a water faucet. When business is strong, they keep paying interest. When business is weak, they can stop paying interest and in exchange assume more debt from their lenders.
"We don't like them," says Mr. McGonigle. If a company decides to exercise its pay-in-kind option, it would be because it doesn't have the cash to service its existing debt, a potentially bad time to be assuming even more debt. "When we get to situations where they turn on the PIK toggle...you could get some surprising volatility." |
