More Private Equity Woes

This article emphasizes that an increasing share of profits must go to pay interest on the debt with which the takeover deal has saddled the firm

Zuckerman, Gregory and Serena Ng. 2007. “Boom Aside, Not All LBOs Look So Hot.” Wall Street Journal (8 June): p. C 1.

“Even as the buyout boom rolls on, a number of recent high-profile deals are already showing signs of strain. Among them: the $1.3 billion purchase of retailer Linens ‘n Things Inc. by a group led by Apollo Management LP; Avista Capital Partners’ $530 million buyout of the Star Tribune newspaper in Minneapolis; and the $17.6 billion deal for Freescale Semiconductor Holdings by several buyout specialists. Apollo’s $6.7 billion purchase of Realogy Corp. also is raising questions among some investors.”

“… recent LBOs have included heavy dollops of debt, potentially causing problems as bond yields climb and the U.S. economy runs into new obstacles.”

“Companies that have gone private in buyouts are generating cash that exceeds their debt interest payments by just 1.7 times, versus 2.4 times last year and 3.4 times in 2004, according to Standard & Poor’s Leveraged Commentary & Data. The ratio is at a 10-year low and shows how the margin for error for companies is shrinking as their profit growth is slowing.”

“The stumbles from LBO firms with impressive track records are a reminder that these deals can be challenging, especially when they take place in cyclical or struggling industries where cash flows aren’t very stable. “Our concern is if there is more of a slowdown in the economy in the second half,” more companies that have been taken private will run into trouble because of the significant debt they have taken on as part of the deals, says Jeffrey Rosenberg, head of credit strategy at Banc of America Securities.”

“This week, investors who purchased loans backing Avista’s buyout of the Star Tribune newspaper learned that the company’s cash flow already is running as much as 20% below Avista’s original financial projections for the deal, which closed just three months ago, according to someone close to the matter. Full-year results also are expected to come in below projections.”

“Some of the loans earlier this week dropped to around 96.5 cents on the dollar before rebounding to around 97.5 yesterday, according to data from S&P LCD. Such levels indicate investors are worried about the newspaper’s ability to repay its debt.”

“At retailer Linens ‘n Things, which was bought by Apollo in February 2006, two consecutive quarters of poor results have sent prices of its bonds down 15% since late February to around 84 cents on the dollar. In an April report, Moody’s Investors Service said the home-furnishing retailer’s cash flow in its 2006 fiscal year was only $30 million, well below expectations of $166 million. Robert DiNicola, chief executive of the Clifton, N.J., retailer that is now part of Linens Holding Co., called first-quarter results “disappointing”.”

“Linens is arguably showing some struggle — but it was marketed to lenders as a turnaround story — so the jury is still out,” Bear Stearns’s Mr. Consoli [s Victor Consoli, co-head of corporate-credit strategy at Bear Stearns] says.”

“Some traders are raising questions about Realogy, a residential real-estate broker that was taken private by Apollo in April and is battling a slumping housing market. Realogy, which doesn’t disclose its results publicly, likely went through a challenging first quarter with weaker sales and rising inventories, said debt research firm CreditSights.”

“A recent “alarming rise in existing home inventories” points to lower revenue and margins for Realogy, CreditSights analysts said. Yields on some of Realogy’s newly issued bonds have climbed to 13.1% from 12.75% when they were issued in April, as prices of the bonds have slipped, according to S&P LCD.”

“Freescale, meanwhile, reported weaker-than-expected results for its first quarter as the semiconductor maker experienced lower demand from its largest customer, Motorola Inc. Freescale suffered a drop in sales and cash flow, which prompted Moody’s to cut its outlook on the company to negative from stable, saying it expects Freescale’s cash flow this year to be weaker than anticipated, which would delay its debt reduction.”


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