It’s actually happening – cheap debt is getting pricier for the buy-out industry, as seen in the recent rejection by investors of loose borrowing terms in some buyout-related debt offerings. And this week brings some potent evidence that investor resistance is stiffening, although views are divided over how seriously this will affect corporate credit.
In one ominous sign for the private equity sector, however, the Wall Street Journal reported on Wednesday that investors issued a resounding ‘No’ to a leveraged-buyout debt offering on Tuesday, leaving banks unexpectedly holding more than $3bn and raising concerns about the changing economics of the takeover boom.
Underwriters pulled a $1.55bn bond offering by US Foodservice, the nation’s second-largest food distributor, which is being bought by KKR and Clayton, Dubilier & Rice from Ahold of the Netherlands for a total $7.2bn. An accompanying plan to sell on debt of $2bn used to fund the acquisition has also been postponed. For now, the banks involved in underwriting the deal will simply have to keep their bridge financing facilities open.
The move “could signal tension in the Wall Street ecosystem”, in which banks, private-equity funds and investors have until now worked hand-in-hand to power the historic buyout binge, says the Journal.
The FT focuses on the dampening effect of the US subprime mortgage debacle on risk appetite and notes that in a growing number of cases, debt investors are demanding higher interest rates and better terms from borrowers, reflecting concern that US subprime lending turmoil could be undermining broader credit markets.
The recent news of losses at two Bear Stearns-managed credit hedge funds has triggered a sharp widening of risk premiums in junk bond markets and elsewhere in credit, suggesting subprime problems are not as cleanly contained as some observers have maintained. In a traditional sign of risk aversion, investors have been buying “safe-haven” government bonds; there is also an apparent unwinding of carry trades in the currency markets, the FT says.
Indeed, the yen gained for a third straight day on Wednesday as a drop in emerging market bonds and stocks prompted investors to pare holdings of higher-yielding assets funded by loans in the currency, reports Bloomberg.
Meanwhile, the end of the cheap debt boom could spell trouble for KKR, which is considering following Blackstone into a public market listing, says BreakingViews.
It would take “months” for KKR to prepare an IPO and by then, cheap debt – a key to the buy-out industry’s success – may be scarce. But the immediate test will be KKR’s buyout of First Data, the payment-processing group, it notes.
KKR must raise a huge amount of new debt in the next few months. It plans a so-called covenant-lite loan of $14bn – nearly twice the size of the biggest such deal to date – and it will float a record $8bn of junk bonds. These will give First Data debt of 10 times its EBITDA.
That’s a bit more than Thomson Learning, being purchased by Apax Partners and OMERS Capital, says BreakingViews. In another sign of investor resistance, that deal has run into problems, as lenders have demanded a higher rate on its loan and rejected a controversial provision on its bonds. Increased borrowing costs, of course, will eat into likely returns.
Thomson Learning is not an isolated event, says BreakingViews. In the past couple of months, certain borrower-friendly practices have been on the wane. The ability to raise cov-lite loans – which give lenders less power if borrowers run into problems – could take a hit, too. S&P plans to penalise the ratings of certain kinds of debt buyers when they invest in such loans.
Meanwhile, lenders have been demanding higher rates for risky deals. Sam Zell recently had to offer a higher rate on a loan to fund his acquisition of Tribune, publisher of the LA Times. Buyout shops are still getting generous terms. But for the first time in more than a year, lenders are not signing off on every deal that comes along. Big deals like First Data are facing greater scrutiny.
If KKR runs into difficulties raising debt for First Data, potential shareholders might question the buyout shop’s ability to keep cranking out annualised returns in excess of 25 per cent. And even if First Data sails on through, KKR is not out of the woods. Its next big deal in the chute is TXU, the Texas utility – with some $33bn in total debt to be financed.