Is Greed Good Again? Leveraged Buyouts Revive
Big-money corporate leveraged buyouts, which became the symbol of late-1980s greed on Wall Street, are making a dramatic comeback this year.
The number of $1-billion-or-bigger LBO transactions--purchases of companies by outside investors, using mostly borrowed money--should reach at least 10 by year’s end, worth a total of $14.1 billion, says Buyouts newsletter in New York.
That would be the greatest number of billion-dollar deals in any one year since 1989.
The LBO revival fits right in with other signs of increasing speculative activity in financial markets--exactly what Federal Reserve Chairman Alan Greenspan was warning about last Thursday.
As LBO investors like Kohlberg Kravis Roberts & Co., Forstmann Little & Co., Clayton, Dubilier & Rice and other giants of the trade hunt for companies or parts of companies to buy, they are tripping over corporate buyers that are also eager to buy competing or complementary businesses as a way to spur profit growth. The LBO firms are flush with fresh cash from pension funds and private investors hungry for robust returns; the corporate buyers can use their high-priced stock as currency.
The result is a flurry of deal-making that not only helps support the stock market overall at these near-record levels but also could provide a cushion should the market suddenly dive--because, in theory at least, many LBO firms would be even more eager to buy companies if their prices came down 10% to 20% or so.
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All that said, these are not your father’s LBOs, if Dad was making deals in the late 1980s. James Zukin, a principal at merger-advisory firm Houlihan, Lokey, Howard & Zukin in Century City, points out that LBO purchases in the wild days of the ‘80s were done with as little as 5% down--the rest, borrowed money. Today, buyers usually are putting at least 20% down, and in some cases as much as 30% to 40% of the deal price is in equity.
A big equity stake--as opposed to 95% OPM (other peoples’ money)--means today’s LBO financiers have much greater incentive to structure deals that work, and to avoid transactions that wind up ruining the purchased company, LBO leaders say. As Tom Hicks, a principal at Hicks, Muse, Tate & Furst in Dallas, puts it: “People are putting up serious money that they are held accountable for.”
The objective of the 1996-style LBO also differs radically from the late 1980s objective. Then, many LBO financiers were in the habit of buying companies just to break them up, selling the pieces for more than the whole (or so the LBO investors hoped). Remember conglomerate Beatrice Cos.?
Today’s LBO buyer, particularly the major firms like KKR and Hicks, Muse, often buys companies that can become private “platforms” on which to build bigger businesses in the same field. That’s what Hicks, Muse has done with its Dr. Pepper/Seven-Up division, and what it expects to do with American Food Products, which it just bought from American Home Products for $1.275 billion.
Of course, the basic goal behind every LBO hasn’t changed: The investors putting up the equity expect to get rich (richer, really) off the deal, as they wring efficiencies from the purchased business, pay down the debt incurred in the purchase and eventually either sell the company to another buyer or take it public at a big premium.
Returns on LBO deals in the ‘90s may be more in the 25%-a-year range than the 40% to 100% annualized returns of the ‘80s, Zukin says, but 25% still is a handsome figure. No wonder that Donaldson, Lufkin & Jenrette Securities last week announced it had raised $3 billion for a new LBO fund, with $750 million coming from the firm and its employees, the rest from outside investors.
But as bankers and major brokerages rush to provide the debt needed to fund these deals (either in bank loans or through the rejuvenated high-yield “junk” bond market), some LBO veterans wonder if Greenspan is right--that there is high risk in paying today’s prices for corporate assets, as set by the zooming stock market.
Los Angeles-based Leonard Green, head of LBO firm Leonard Green Partners, admits that he has been in “liquidation” mode this year, selling his stakes in businesses such as Thrifty Drug Stores, grocery chain Kash ‘N Karry, and vitamin maker Twinlab Corp., either to other corporate buyers or to the public via stock offerings. “I think it’s probably better to sell at this point” than to buy, Green says. So far, however, the bull market can be thankful that Green’s is still a minority view.
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Big Deals are Back
Big-ticket leveraged buyouts are back in vogue this year for the first time since the late 1980s. Value of LBO deals worth $1 billion or more, annual totals, in billions:
1996*: $14.1
* Estimate
Source: Securities Data Co.; Buyouts newsletter
