Debt crunch puts buyouts in jeopardy
new york -- Like airplanes backed up on a runway, dozens of pending multibillion-dollar corporate buyout deals involving such familiar names as Hilton Hotels and Clear Channel Communications are waiting to take off.
But if Wall Street’s instincts are correct, the global credit crunch may ground some of them. Plunging stock prices of companies that have already agreed to be bought at higher values suggest that investors believe some deals could be shaky.
There’s more at stake than big year-end bonuses on Wall Street. Any fallout from a string of busted buyouts could hit a lot of ordinary people, experts say.
That’s because a slowdown in merger activity and the scrapping of existing deals could hurt the overall stock market, which rode the frenzy of buyouts the last few years led by investment banks and huge private equity funds. Declining stock values could sap consumer confidence and consumer spending, which in turn hurts the economy and ultimately puts people out of work.
What’s more, so many Americans are invested in the stock market through their IRA and 401(k) accounts that, even if their jobs are safe, their retirement savings could suffer.
“This is a classic crisis of confidence, not a problem with economic fundamentals,” said James Bianco, a Chicago-based bond analyst and investor. “But that doesn’t mean it couldn’t cause harm.”
The Federal Reserve stepped in Friday to try to calm markets’ frayed nerves by cutting the interest rate at which it lends to banks. The Fed said it acted because “financial market conditions have deteriorated” as lenders pulled back from extending credit in recent months.
Stocks rallied Friday, and the trend this week may show whether investors -- and lenders -- are regaining confidence.
Market pessimists say there is more pain to come as banks and investors cope with the hangover from years of easy credit and a blase attitude toward risk. Future deals, when they come, will be done at lower prices, at higher interest rates and with more realistic -- that is, harsher -- terms for borrowers.
More optimistic analysts say that, although home sales and prices are falling from record highs, rising mortgage defaults -- the root cause of credit concerns -- aren’t as pervasive as the investor reaction would suggest.
It’s also hard to get a fix on how severe the financial markets’ problems are because August is the slowest month on Wall Street, and things could change after Labor Day.
In the meantime, scores of buyout deals are waiting to close.
Among the higher-profile ones are radio giant Clear Channel Communications Inc., which agreed to be sold for $19.5 billion to investors Thomas H. Lee Partners and Bain Capital, and hotel chain Hilton, which plans a sale to Blackstone Group for $26 billion.
On Friday, Clear Channel shares closed at $35.07 and Hilton ended at $44.74, reflecting discounts of 11% and 6%, respectively, from their buyout prices. Both stocks have bobbed around in recent days but were up in Friday’s rally.
More mega-deals are awaiting completion today than at any other time in history, thanks to the frenzied competition earlier this year to take companies private in leveraged buyouts.
Citigroup analyst Prashant A. Bhatia has counted 47 pending transactions valued at $1 billion or more, led by private equity firm Kohlberg Kravis Roberts’ record $37-billion agreement to buy the Texas-based electric utility TXU Corp.
“The backlog will take several months to clear,” Bhatia said. “The volume of deals will slow down and very big deals won’t happen at all.”
The spreading turmoil shows how interconnected the global financial markets have become, with the increasing convergence of laws, currencies and Internet communications. Ripples from the crisis in the riskiest part of the U.S. mortgage market, involving so-called sub-prime home loans because they are made to people with poorer credit, splashed across borders to Asia and Europe and across investment sectors to the seemingly unrelated market for corporate bonds.
What’s happening with mortgages affects corporate bonds because, in many cases, the investors are the same people. A hedge fund that borrowed money to invest in mortgage-backed securities and is now facing repayment demands from its lenders may be forced to sell its corporate bonds to raise cash. That pushes down bond prices, even if the corporations issuing the bonds are doing good business and have no trouble making payments.
Many of the pending buyouts were cooked up last spring when the spreads -- or difference in interest rates -- between the yields of super-safe Treasury bonds and riskier, high-yield “junk” bonds were at near-record low levels of less than 3 percentage points, according to economist John Lonski at Moody’s Investors Service. Since then, he said, spreads have widened to about 4.3 points.
Widening spreads reflect a rising perception of risk, increasing the anxiety of investors. Spreads haven’t widened as much this year as during the 1998 Asian crisis. That could mean either that the current problems are relatively mild or that things could get a lot worse.
Panicking mortgage-market investors are dumping high-quality securities along with junk. In such an environment, investors are shrinking away from risk in every category of debt.
“The market that is actually taking all this the best is the stock market,” Bianco said, noting that the Standard & Poor’s 500 index is down less than 10% from its July 19 all-time high.
Bond investors, however, have become far more skittish, which is a big problem for the investment banks involved in the mega-deals.
The banks agreed to finance the buyouts with the intention of selling loans or bonds to outside investors. But now, with bond investors balking, the banks may be forced to keep much of the debt on their own books.
That means they will have less money available to lend until bond buyers come back to the market.
Hollywood, which is increasingly counting on outside money to fund films, also is watching the credit tightening closely.
Last week, the Financial Times reported that Goldman Sachs and Deutsche Bank pulled back from a commitment of $700 million to $1 billion to finance a slate of movies for Metro-Goldwyn-Mayer that included “The Hobbit,” “Terminator 4” and the next edition of the James Bond franchise.
MGM disputed the report, saying it remained in discussions with Goldman Sachs and other banks but chose not to do a deal now. The studio did complete a $500-million financing for United Artists, which it is reviving with Tom Cruise and his producing partner, Paula Wagner.
Nonetheless, a Lehman Bros. report notes that big banks are having trouble “syndicating” their deals, or repackaging them into bundles to be sold to investors, because the investors aren’t biting. The slowdown, according to Lehman, eventually could hurt the parent companies of the major studios: Disney, News Corp., Time Warner and Viacom.
Much of the buyout fizz already has evaporated from some stocks rumored to be candidates. Shares of potential targets such as Macy’s Inc. and RadioShack Corp. have plunged by as much as one-third from month-ago levels as deal rumors have died down.
As for the buyouts that are pending, experts say most of them ultimately will close because the banks’ financing commitments legally compel them to follow through unless there is a fundamental business change in the companies involved. Investor reluctance to buy bonds doesn’t count.
Typically, when a buyout is announced, trading in the stock becomes dominated by Wall Street specialists known as risk arbitrageurs, who speculate on the likelihood of the deal being completed. If a deal is struck for $50 a share and is expected to close in six months, the shares might trade at $47 or $48, with the discount, or spread, reflecting the traders’ cost of tying up their money for six months plus the risk of cancellation.
Shareholders of SLM Corp., the student lender better known as Sallie Mae, Wednesday approved a $25-billion -- or $60-a-share -- buyout by the private equity firm J.C. Flowers & Co. Although the deal is scheduled to close in October, the stock closed Friday at only $48.26, 20% below the agreed price.
The clear message is that Wall Street doesn’t expect the deal to get done, at least on the current terms. Flowers announced last month that pending legislation in Congress to cut student loan subsidies constituted a material business change that was grounds for scuttling the deal. Cynics thought the firm was seizing on the adverse legislation when its real reason for wanting out was that the crisis in the credit markets would make its financing much more expensive.
Another deal that Wall Street is nervous about is the $8.4-billion buyout of Tribune Co., being led by Chicago investor Sam Zell and a newly created employee stock ownership plan. Shares of Tribune, which owns the Los Angeles Times, closed at $25.67 Friday, 25% below the $34 offer price on a transaction scheduled to close in the fourth quarter.
Since the deal was announced April 2, Tribune’s advertising revenue has plunged steeply and steadily, calling into question the company’s ability to service the huge amount of debt it is taking on.
With a shareholder vote on the deal scheduled for Tuesday, Zell wasn’t commenting, although people close to him have said the deal is on track. Tribune executives also have said repeatedly that the financing commitments are solid and the deal will close as scheduled.
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