Bad Buyouts and What We Could Do about Them
January 7, 2010
Allied Stores. Burlington Industries. Charter Medical. E-H Holdings. Federated Department Stores…
If you were around back in the day, otherwise know as the 1980s, these deals might ring a bell. These companies are among the 13 that, between 1985 and 1989, issued a billion or more in junk bonds to help fund a buyout—then promptly went bankrupt. Those 13 make up roughly half of the 25 deals of this size done in that period, as Josh Kosman points out in his recently published book The Buyout of America.
Kosman, a veteran financial journalist and business reporter for The New York Post, takes the buyout kings to task in the book, upending their claims of building leaner, stronger companies with example after example of companies, many of them healthy to begin with, left hobbled or completely shattered following a takeover by private equity.
He cites examples from the 1980s, the 1990s—of the top 10 LBOs done that decade, six of the companies were left worse off afterwards—and he makes predictions concerning the most recent buyout boom and the hundreds of billions of debt coming due between 2012 and 2015.
The infamous maturity wall. Perhaps you’ve heard tell of it. Will it be a replay of the 80s LBO fallout, with a 50% bankruptcy rate, but on an immensely larger scale?
Kosman thinks it could. And while I don’t believe it will come to that, as we have seen a significant number of companies refinance their 2010 and 2011 debt through high yield bonds, and both the junk bond and leveraged loan markets appear poised for a continued up cycle, there will certainly be plenty of companies that can’t refinance. There will certainly be plenty of bankruptcies.
How this situation came about—a market tilted so far toward the sellers as to create a frenzy of brazen issuance—is both regrettable and irreparable. Spilled milk. But we could do something about the future if we wanted to.
When the deal market starts heating up again, target companies and banks could demand that private equity firms take on more risk, put up more of their own money. And investors could speak with their feet, shunning buyout debt that looks like it will drown the issuer.
It sounds easy enough, but consider this: As Kosman notes, early in 2007, Moody’s Investors Service cautioned that a number of specialty retailers, including Linens ‘N Things, would NEVER be able to pay back their buyout debt without sizable increases in cash flow. The 2006 buyout of Linens ‘N Things, for $1.3 billion, had been led by Apollo Management, which put up about 2.2% of the money in the buyout fund that made the downpayment. Linens ‘N Things went bankrupt and liquidated in 2008.
A lesson learned? Sigh... If only...