LBO debt spreads widen, PE deals looking rocky

Not that most of us are in the market for billion dollar loans, but if you are, now is not the best time to be trying to get the perfectly priced deal, with few, if any, covenants:

– underwriters pulled a US$1.55 billion bond offering for U.S. Foodservice earlier this week, and they’ve also postponed plans for a US$2 billion debt package to fund the acquisition by KKR and Clayton, Dubilier & Rice of that Royal Ahold asset for US$7.2 billion
– Servicemaster’s LBO needed to reduce the amount of PIK (pay-in-kind) interest in that US$4.8 billion buyout before folks would nibble; debt investors concluded that there was a high likelihood that the equity sponsor would quickly revert to paying interest in paper, rather than cash
– Apax Partners and OMERS Capital Partners are obstensibly having trouble raising US$5.6 billion of bonds and bank debt to pay for their acquisition of Thomson Learning. According to the Wall Street Journal, US$1.6 billion of bonds were sold only after terms were improved, but a US$540 million bridge loan remains outstanding – and may for a long time to come

For the first time in years, debt providers appear to be getting some spine when it comes to price and structure. Perhaps they got tired of reading comments from U.S. bank CEOs about how silly things had become (see “Maybe there is a credit bubble after all“, June 1-07). While it has been a few months since the subprime melt got rolling, it appears as though the Bear Stearns challenges got everyone’s attention. It is one thing for a small lending shop in California to go bust, but pension funds notice when the Bear needs to find US$3 billion to satisfy a liquidity crunch at a debt fund (see “US subprime borrowers sink deeper into trouble“, June 15-07).

“There appears to be a broader correction in the marketplace,” Clayton Dubilier spokesman Thomas Franco, in the Wall Street Journal.

All this comes at a bad time for funds trying to raise money for deals that needed to be levered to work:

– KKR needs US$14 billion in loans to complete the First Data transaction, and another US$8 billion in high yield bonds (or at least today’s version of “high yield”)
– once that deal is completed, KKR needs another US$33 billion in debt to close the TXU deal

“The pendulum has swung from being a very issuer- friendly market to one that is less friendly.” Paul Scanlon, head of high-yield at Putnam Investments.

Here’s a fact that you might have missed:

In 2006, there were US$194 billion of buyout deals for over 1,000 companies, according to Dealogic. US$163 billion was borrowed to pay for those buyouts, according to S&P; more than the total borrowings for the two prior years combined. And while Henry Kravis advises that 30% of their deals are funded with equity (see “Henry Kravis on ‘the bubble’ question“, May 31-07), the entire industry can’t make that claim, as $163B represents 84% of the aggregate deals closed…so, 16% was funded in equity. Half what Mr. Kravis thought/claimed/does, according to S&P and the WSJ.

Here’s a thought. If the 6 largest U.S. bank CEOs got together for lunch and took a vow of “no more cov-lite” debt deals, would the U.S. Department of Justice open a file in their anti-combines branch?

In the meantime, the debt market appears to be tired of being slapped around by people who have 16 cents at risk for every 84 cents being put up by the lender.

MRM