Tight Credit Could Stall Buyout Boom

Tight Credit Could Stall Buyout Boom
Crunch Complicates Some Pending Deals

http://www.washingtonpost.com/wp-dyn/content/article/2007/08/11/AR2007081101351.html?nav=rss_print/asection

By David Cho and Thomas Heath
Washington Post Staff Writers
Sunday, August 12, 2007; A01

The severe turmoil in the credit markets last week has raised serious questions about the future of the buyout craze that gave rise to the biggest deals in U.S. corporate history.

For the past few years, a group of elite Wall Street players have been buying up major American icons and taking them private. These massive acquisitions have depended on access to cheap credit, which is supplied by a complex relationship between investment banks and hedge funds.

But with credit markets tightening, the pace of these deals, at least in the short run, is expected to dramatically slow. Already-announced multibillion-dollar buyouts, like Tribune Co., Sallie Mae and Hilton Hotels, are likely to be far more complicated to close, analysts said.

If one or two of these big deals were to collapse, it might not send the economy into a downturn. But it would profoundly shake investors' confidence in a financial system already under siege from billions of dollars in losses from home mortgage defaults. That could make it even more difficult for companies and home buyers to get loans.

Private-equity firms, which use big pools of private money to buy companies, generally describe the tightening credit as a temporary setback. But some market watchers are predicting the end of the buyout boom. Either way, both sides say, the private-equity movement is at a crossroads.

"There is a crisis of confidence in the credit markets that is . . . letting a little helium out of the buyout balloon," said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship.

Buyouts are credited with bringing efficiency to industries such as steel and airline parts. But they are also criticized for forcing employees to take on more risk for the success of their companies, as in the case of Tribune. The deals created a new class of powerbrokers, like Stephen A. Schwarzman, who made $400 million last year and holds about a $6.4 billion stake in his company Blackstone Group. But they also enriched universities and pension funds that have been increasingly investing in private-equity funds and helped propel the stock market to new highs.

Fueled by easy-to-get money from the credit markets, buyout shops gained the ability to acquire all but the largest corporations in the past few years. Many companies began to see the benefits of going private -- they could get funding from buyout firms and did not have to deal with the scrutiny that comes from being public.

This year, buyout shops announced $600 billion worth of acquisitions and were on track to set a record, according to Thomson Financial. But in July, the number of deals dropped considerably. And many companies that had agreed to be bought out by private-equity firms are now seeing their shares slump before the deals have been consummated, a Wall Street bet that these agreements will be renegotiated or fall apart.

The stock of Tribune Co. closed Friday 22 percent below the price real estate mogul Samuel Zell agreed to pay in April. Zell is acquiring the media company for $13.2 billion. Shares of Hilton Hotels recently have traded 12 percent below what private-equity giant Blackstone consented to spend in July. It agreed to buy the hotel chain for $26 billion.

One deal that analysts say is particularly vulnerable is the $25 billion acquisition of Sallie Mae. Its stock closed 20 percent below its deal price Friday.

In April, the student loan giant announced that it had agreed to be acquired by buyout firm J.C. Flowers for $25 billion. The deal was hailed as a breakthrough for private equity which had never before been able to acquire a major financial firm. Other financial stocks, such as Bank of America and Student Loan Corp., rose on the news as traders speculated the Sallie acquisition would lead to a frenzy of new buyouts in the financial sector.

Now four months later, the Sallie Mae acquisition is facing difficulties and none of the other deals have happened. On Thursday and Friday, as the market scrambled to cope with the global credit crunch problems, Sallie's share price fell about 3 percent.

One problem with the deal is that it is being funded with $16.5 billion in debt. Borrowing that amount of money was cheaper earlier in the year. But it is far more expensive now because the credit markets are more sensitive to risk and are less willing to issue loans with generous terms and low rates, noted Richard Hofmann, analyst at CreditSights, who has followed the Sallie Mae situation closely.

"We believe [J.C. Flowers] wants to walk away because of what's happening in the credit markets," Hofmann said.

A person who spoke on the condition of anonymity because he is not authorized to speak publicly about the deal said that J.C. Flowers is fighting to back out of the deal or at least lower its price. A J.C. Flowers official declined to comment Friday, while a spokesman for Sallie Mae said the firm expects the buyout to close in October.

As deals stall, the two most powerful players on Wall Street that rode the buyout wave to riches -- investment banks and private-equity firms -- are suddenly locked in a contentious battle over who is going to pay for the mess.

"It's kind of a game of chicken right now," said Greg Peters, chief credit strategist at Morgan Stanley. "There is not a lot of give and take going on, and ultimately that's what you are going to need."

The problem is that large investment banks, including Lehman Brothers, Goldman Sachs, J.P. Morgan and Morgan Stanley, have committed to provide money for private-equity firms to make these deals. They were willing to do this because in the past they could slice and dice these loans into pieces and sell them to hedge funds and other investors around the world, including major financial institutions in Japan, France and Germany.

It was the willingness of these investors to take on these pieces of debt that fueled the era of easy money over the past few years. The risk of lending could be spread across many players. Now, spooked by several big hedge fund collapses and a widening crisis in the mortgage industry, these investors are saying no.

"The whole system is choked up," said a hedge fund manager, who spoke on the condition of anonymity because he did want to endanger deals he has in the works. "The buyers, like us, are saying -- 'Not a chance.' . . . We are getting calls today from banks that have this inventory they want to get rid of. They want to get rid of everything they can, even if they have to take a hit on it."

With hedge funds and other investors refusing to buy such debt, investment banks have to sell them at a severe discount to investors or hold on to them. Keeping the debt can be painful for investment banks because they would have to absorb the losses if the borrowers default. A large inventory of unsold loans also means less revenue for banks. Wall Street banks are currently holding $289 billion in unwanted debt, according to research firm Dealogic.

Alarmed bankers are pushing private-equity firms to scuttle deals or renegotiate prices, which most private-equity firms do not want to do. Such disputes are putting the relationship between these powerful players in jeopardy. Their partnership has been at the heart of the buyout boom and the source of enormous wealth for Wall Street.

No activity has been more profitable to investment banks than private-equity buyouts, which typically provide more than $1 billion in fees every year.

Wall Street insiders acknowledged that the buyout run is being tested. "The process is slowing down because everybody is more cautious," said Donald Marron, chairman and founder of private-equity firm Lightyear Capital. "Everybody wants to think about things a little more."

Looks like Stephen Schwarzman tripled Blackstones net income.  Buyouts I found happened a lot between companies with current and past executive level ties.  I found a map of Schwarzman's connections at http://www.newsvisual.com/newsvisual/2007/08/steve-schwarzma.html, might be of use in predicting future events. 

Very interesting.  Thanks a lot for contributing, Karen.  I hope to see you here some more.

Edited 1 time(s). Last edit at 08/21/2007 01:11AM by regli.