Junk Bond Buyouts Reemerging as Deals Get Bigger
As the trademark deal of the 1980s, the junk bond buyout was the weapon used for raids on corporate giants. Now, it looks poised to make a comeback as financiers seek funding for bigger, costlier targets.
A $268-million junk bond sale last week by ConAgra Foods Inc. unit Swift & Co., part of the financing for a $1.4-billion leveraged buyout of the company, could be the harbinger of a raft of such deals to tap the recovering junk bond market, experts say.
“The ‘leverage’ in leveraged buyouts has been fairly nonexistent,” said Jesse Reyes, vice president for research firm Venture Economics.
“As the high-yield market tends to open up,” he said, “I think you’ll be seeing a lot more of these transactions.”
In a leveraged buyout, a group of investors buy a company with borrowed money--a mix of loans and bonds--using the company’s assets as collateral. The use of debt allows investors to take over a company with little of their own capital, with the potential for stunning returns.
In recent years, however, high share prices kept leveraged buyouts out of the biggest corporate acquisitions, which were financed with stock rather than debt.
“Prices were too high for leveraged-buyout sponsors to put money to work in large transactions involving publicly held companies,” said Chris Donnelly, a director at Standard & Poor’s PMD, which tracks leveraged lending. LBO sponsors instead targeted small companies or divisions, and those deals were not large enough to justify a bond sale, he added.
“Deals were small enough so they would be financed in the bank loan market,” Donnelly said. “You’re seeing some extraordinarily large transactions announced again.”
Qwest Communications International Inc.'s phone book unit QwestDex plans to sell up to $1 billion in junk bonds to help pay for its $7.05-billion takeover by two buyout firms. That deal would be the largest since Kohlberg Kravis Roberts & Co.'s $31.4-billion buyout of RJR Nabisco in 1989.
As leveraged buyout sponsors circle bigger targets, the dollar volume of deals has surged. Some 109 deals totaling $15.7 billion have been completed or announced this year, compared with 138 deals totaling $9.3 billion in the same period last year, according to Thomson Financial.
Leveraged buyout activity was muted last year partly because of the recession, said Morton Pierce, head of the mergers and acquisitions group at Dewey Ballantine in New York.
“Banks are very reluctant to lend money when the economic climate is not very good and subordinated-debt buyers are more reluctant to buy,” he said.
Lean times recently have helped leveraged buyout sponsors get back in the game for large deals. Financially strapped companies are putting assets on the block, sometimes at knockdown prices, while conglomerates are selling off their weaker pieces. Leveraged buyout firms also are working together so they can do bigger deals.
British-based drinks firm Diageo in July sold its U.S. hamburger chain Burger King for $2.26 billion to Texas Pacific Group, Bain Capital and Goldman Sachs Capital Partners. Burger King is expected to issue high-yield bonds to help pay for the buyout.
This type of deal uses far less debt than in the no-holds-barred 1980s. LBO firms on average fund their deals with about 62% debt, compared with 93% in the late 1980s.
At first blush, conditions in the high-yield market do not appear favorable for LBO financings. Investors have become edgier about taking on risk after a summer of accounting scandals and bankruptcies such as those of telecom giant WorldCom Inc. and cable firm Adelphia Communications Corp.
Yet junk bonds are showing some signs of a turnaround. Yields on the bonds, which move in the opposite direction of price, have fallen to an average of 13% from 13.5% a month ago.
Investors also are returning to the sector, pumping a net $2 billion into junk bond mutual funds over the last three weeks, according to AMG Data Services.
“The [LBO] deals we see in market are the first indication that once again sponsored transactions do have access to the capital markets,” said Edward Mally, head of high-yield research at CIBC World Markets.
LBOs could trigger significant bond issuance, experts say, if the high-yield market regains strength. “If it’s healthy,” S&P;'s Donnelly said, “the sky’s the limit.”