Recent LBO Mega-Deals Have Much Higher Default Rates

LBOs by Cerberus and Apollo are performing much worse than other private equity deals, while deals by KKR, JP Morgan and Welsh Carson have seen better performance.

Excerpts from Private Equity: $640 Billion & 640 Days Later

The 10 largest leveraged buy-out deals financed in the 2005-2007 credit market peak have had rates of default or distress that far exceed those of companies not owned by private equity groups—and of other, smaller LBO deals.

Six of the 10 biggest LBOs that Moody’s has tracked are considered distressed, and four of those have defaulted.

Only three of the biggest 10 LBOs remain above the distress level, according to Moody’s: HCA bought by a private equity consortium for $35.3 billion; First Data, another “Large Club” LBO, acquired for $29 billion; and Hertz, bought out by a private equity consortium led by Carlyle for $15 billion in 2005.

Moody’s report examined the performance of 186 rated LBOs sponsored by the 14 largest U.S. private equity firms. These transactions have experienced a 19.4% default rate since January 2008 — similar to the 18.5% weighted average default rate for similarly rated companies, Moody’s data showed.

So far, private-equity takeovers have not looked much more risky or prone to default than ordinary issuers.

“But this could change as more debt comes due over the next 1-3 years, unless the market becomes more willing to refinance highly levered companies, or these private equity firms become more prepared to provide equity infusions to help their sponsored companies avoid default.”

Unlike the rate of default, the number of LBO deals considered distressed — rated B3 (negative outlook) or lower — is significantly higher than for similarly rated companies. About one-fifth of LBOs are distressed, compared to only about 14% of general corporate issuers, Moody’s data showed. The firms’ levels of LBO distress or default ranged from as low as 15% to as high as 67%.

Other findings:

• Capital infusions have been rare during the past two years, and have been used mainly to help companies avoid covenant violations, not to reduce leverage.
• Companies that paid out dividends to their private equity sponsors during the first year of ownership have defaulted at rates similar to other deals that have not paid dividends during the first year, and to similarly rated companies.
• With many LBOs already in distress—rated B3 (negative outlook) or lower—we believe the wave of debt maturing in the next 1-3 years will increase refinancing risk, and could prompt additional defaults.

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