Sunday, 22 July 2018

Jumbo LBOs back in the reckoning

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BONDS Conditions are ripe for the return of mega-buyouts

With bond markets still risk-on and piles of cash looking for a home, the window could again be wide open for jumbo leveraged buyouts, banking and industry sources say.

In the past few weeks, talks have been held for at least two super-sized LBOs - one in software and one in healthcare - the sources say.

“A lot of people are asking questions,” one executive at a private equity firm told IFR. “And a lot of banks are putting together market-capacity analyses.”

Private equity firms have raised record amounts of cash for new funds, while bond and loan investors have shown a willingness to take on more risk amid modest default rates.

Even as a number of energy and retail companies struggle to stay afloat, the default rate for junk-rated companies in the US is expected to decline to 2.8% by June 2018 from 3.8% in June of this year, according to S&P.

Pension and sovereign wealth funds - among the largest clients of PE firms - are meanwhile looking for opportunities to boost returns, including through direct equity investments in LBO targets.

“All the people who invest money are dealing with a world in which there is more capital than opportunities,” one banker said.

“They are calling us and saying: Bring us ideas. We are investors in private equity funds, but if you have good deals, show them to us - and we can be flexible.”



Still, jumbo LBOs are toxic in the eyes of many investors - due to some spectacular failures in the financial crisis - and the negative perception could limit potential deal sizes.

“I think many in the private equity industry are still a bit gun-shy about mega-deals,” said Ron Cami, a partner at law firm Davis Polk and former in-house lawyer at TPG.

The last big boom in super-sized LBOs came around over a decade ago, when rival private equity firms would join forces to push deal sizes into the tens of billions of dollars.

But many of those companies ended up carrying unsustainable levels of debt, and several were forced into bankruptcy.

KKR and TPG’s US$45bn takeover of TXU in 2007, for example - still the largest corporate buyout ever - added a whopping US$25bn of new debt, ultimately leading the Texas utility into Chapter 11.

Others went through restructurings and recapitalisations, as sponsors had no choice but to hold the investments for much longer than originally anticipated.

Finding opportunities in the current seller-dominated environment could also pose a challenge for private equity firms.

“I don’t think you will see the large number of mega-deals that we saw in the early and mid-2000s,” said Cami.

“It’s not chasing rainbows, but if deals of US$20bn size happen, I think it is going to be episodic.”



Michael Dell famously joined forces with Silver Lake Partners in 2013 to take the company he founded private for US$25bn in the largest leveraged buyout since the crisis.

But that feat might not be easy to replicate.

For one thing, private equity sponsors and their co-investors could potentially have to cough up US$5bn or more in equity to ensure leverage and ratings are acceptable to investors.

That would be a sizable amount even for heavyweights such as Apollo Global Management, Blackstone and KKR, which have some of the largest equity war chests in the industry.

Underwriting and selling US$15bn or more of junk-rated debt to support such a deal would also be a stretch, according to some.

“You have to have a pristine business, something that everybody wants to own and not too much leverage,” said a second leveraged finance banker.

“You have to tap every dollar in the market to potentially get it done.”

It could also be a risky bet for Wall Street lenders at a time of increased worries about expensive equity valuations and frothy credit markets.

“The consequences to the balance sheets of banks committing are significant,” said Richard Farley, partner and chair of the leveraged finance group at Kramer Levin.

“They will need a significant amount of pricing flexibility for those commitments.”


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