More Trouble Ahead for Private Equity Deals

by: Prince of Wall Street

Now that the Alliance Data (NYSE:ADS) buyout is supposedly “back on" (after an attempted shutdown by Blackstone (NYSE:BX)), some in the financial press might anticipate that future private equity buyouts will go more smoothly than the Alliance Data deal. It would be a mistake, however, to believe that other buyout deals have an easy road ahead. Many interested parties have incentives to hold up the deals. Investment banks want to see deals collapse, so they don’t have to take a bath on the committed financing packages they have given to PE shops for the deals. Regulators are also becoming more careful about approving deals that have foreign investors as co-investors. Even the PE shops themselves in some cases don’t want to finish some of their completed deals now that the economy is slowing. Many PE shops are also careful to not invoke the Material Adverse Clauses (NYSE:MAC) in their merger agreements, because they don’t want to acquire a reputation for such actions when deals they agreed to don’t look so appealing due to the economy. Unfortunately, the PE firms and the sellers of companies successfully forced investment banks to give up the MACs related to ability to finance when the credit for LBOs was cheap. Many PE shops didn’t want to give investment banks any wiggle room back then with financing commitments. Had the PE firms not removed the ability of investment banks to declare a MAC, we would no doubt see PE shops pressuring their investment bankers to invoke a MAC to stop deals that the PE shop doesn’t want to consummate. The PE shops would have the option to make the investment bankers the bad guys while getting their way. It seems like the worst part to play in this drama is that of a seller. The security of your buyout being completed successfully is being attacked from all sides, and your business is probably not worth as much as it was at the height of the LBO boom when your stock was higher.

If you need specific examples of the problems that are plaguing other LBOs in the pipeline The Deal and The Deal’s Dealscape Blog have done some great work on this subject.

First up, is Bain Capital’s $2.2 billion buyout of 3Com Corp. which has raised the ire of a U.S. national security panel. The panel is concerned about the Chinese company that is Bain’s co-investor. The U.S. Committee on Foreign Investment recently made it clear that proposals to preempt concerns about Huawei Technologies as a minority investor were unconvincing. CFIUS doesn’t want Huawei to gain access to 3Com’s sensitive encryption technology. This concern prompted Bain and 3Com to withdraw their application for approval by CFIUS on Wednesday. This move certainly is ominous for the prospects of this buyout actually getting done. It could be the case that Bain will use the regulators as the scapegoat to walk away from this deal. What is unclear is if Bain still wants 3Com, even though technology spending is bound to slow given the recession.

A far bigger and more market moving deal is also on the ropes. Clear Channel Communications' (CCU-OLD) $26 billion buyout has been plagued by problems at every step of the way. This deal was supposed to close months ago, but everything from deal price to shareholder approval has been a problem. Now marketing the debt for the LBO by Thomas H. Lee Partners LP and Bain Capital LLC is looking predictably dicey. Since Blackstone’s failed purchase of Alliance Data, other problems have been encountered on the Harrah’s Entertainment and Intelsat deals. Clear Channel’s troubled sale of its television unit to Providence Equity Partners, now the subject of a Delaware lawsuit hasn’t helped ease the banker’s concerns. Add that to the fact that ad spending is declining as the economy falters, and companies operating in radio look like a poor place to be deploying money at such a high multiple. Remember the Clear Channel buyout was, and still is, the poster child for an LBO with a purchase price that was a sky high multiple of EBITDA in a cyclical industry. If you need proof that radio is tough, the Radio Advertising Bureau just announced that industry revenue fell 5% in January, and national ad sales dropped 13%.

This deal has been in the pipeline forever. This deal was announced in November 2006. The bid was boosted from $37.50 to $39 after shareholders complained. Finally, the bid was raised to $39.20, and the investors were allowed to retain minority equity. The deal is now supposed to close in March but the Prince is very doubtful on this one. The Federal Communications Commission also held the deal up for more than 380 days and was finally cleared in late January. The Justice Department just gave approval in February.

Yet, we still haven’t got to the marketing problem for the debt to finance this deal. Needless to say there are not debt investors lining up to take down the debt of an over-levered company facing industry headwinds. The banks are going to push back on their commitments and it will be interesting to see how hard a line Bain and Thomas H. Lee take with the banks. The debt will be marketed until March 26, but financing this much paper doesn’t seem possible given the state of the markets and the weakness of the operating company in this LBO. Citigroup (NYSE:C), Deutsche Bank (NYSE:DB), Credit Suisse (NYSE:CS), Morgan Stanley (NYSE:MS), Royal Bank of Scotland (BS) and Wachovia (NASDAQ:WB) have committed $22.13 billion in financing, including senior secured credit facilities, in an aggregate principal amount of $18.53 billion, a receivables-backed credit facility with a maximum availability of $1 billion and a senior bridge loan facility of $2.6 billion. The banks want covenants tightened in the deal (because there isn’t a bid for debt that is of the covenant-lite variety peddled successfully to debt investors during the height of the LBO boom), and the PE shops are rumored to still want the deal to get done. The Prince is highly doubtful that this thing will get financed. However, this deal has already cleared so many larger road blocks that he thinks it will still go through, with the banks taking a bath if they try to syndicate the debt or writing bridges to get the deal closed.

Now let’s move on the big elephant in the room. That is the enormous loan package needed for the LBO of BCE (NYSE:BCE): The $23bn loan needed by Ontario Teachers’ Pension Plan, Providence Equity Partners and Madison Dearborn Partners for the buyout of Canadian telecom BCE Inc. The looming financing, which was expected to hit the market in the first quarter, is drawing more scrutiny. However, a lawsuit by Canadian bondholders, who claim they have been oppressed by the adverse effect the new debt will have on existing bonds, has scrambled the timeline somewhat. A ruling by a Quebec court is expected in the coming days, but the appeal process could drag the case out for some weeks. Bondholders and BCE agreed to an expedited appeal process, with a final ruling expected within 30 to 90 days after the appeal is filed. If bondholders lose, financing arrangements will be finalized soon after. Yet, who knows if this debt will get sold to investors? The deal is in a more stable industry and isn’t as absurdly levered as Clear Channel, so this one’s debt may have a chance of getting sold to investors. However, the buyers have said publicly that they won’t complete the LBO if the bondholders win the suit.

Finally, we end with the deal that seemed doomed from the start: Goodman Global. San Francisco private equity firm Hellman & Friedman, a firm which The Prince really likes and respects, finally completed a $25.60-a-share, $2.65 billion leveraged buyout of Goodman Global. It bought the air-conditioning equipment business from Apollo Management which had acquired it in 2004. Barclays (NYSE:BCS), GE Commercial Finance, Crédit Agricole’s Calyon New York subsidiary, GSO Capital Partners and Farallon Capital Management arranged $1.6 billion of debt financing for the LBO. An $800 million term loan garnered more than $900 million in interest after the banks sweetened the terms: launched at LIBOR plus 375, with a 98.5 original issue discount, the five-year loan eventually was placed at LIBOR plus 425 and at a discount of 96. In addition, a LIBOR floor of 3.25% was set for the life of the loan. The relatively small size of this financing and the stableness of Goodman’s business probably contributed to the banks’ success in selling these loans. It is ironic that the deal that seemed on the ropes when the buyout boom was still strong and constantly plagued by problems, is the standout success in a sea of trouble for other PE LBO deals.