The Washington Post thinks the recently announced deal by Silver Lake Partners and Texas Pacific Group to take telecommunications equipment maker, Avaya, Inc. (NYSE: AV), private indicates a perilous decline in credit standards. And the Post thinks this decline will contribute to the end of the takeover boom.
I always feel a bit skeptical when I read these kinds of articles. It's not so much that the logic is flawed, but the timing is often hard to pin down. I am guilty of doing the same thing myself since I wrote something similar last August. And yet the takeover boom refuses to bend to the will of the pundits.
The Post believes there are three reasons why the takeover boom has peaked:
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Credit standards are declining. In 2004, Standard & Poor's calculated that operating profits for companies involved in leveraged buyouts were typically 3.4 times debt service. In 2006, the number fell to 2.4. So far this year, it is 1.7. And the Avaya deal's was an even lower 1.3.
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Interest rates are rising. Yields on the benchmark 10-year Treasury bill have increased from just under 4.5% to more than 5.25% -- a 75 basis point jump without any action by the Fed.
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Private equity is having more trouble getting financing. For example, KKR is having trouble financing its $26 billion acquisition of First Data Corp (NYSE: FDC). Moreover, syndicated loans used to pay for recent private equity deals are declining in value. For example, the loans used to purchase the Minneapolis Star Tribune, Linens 'n Things and Freescale, a semiconductor maker, are trading at significant discounts only months after the deals were closed because the companies reported disappointing earnings or cash flow.
The Post may well be right but things will keep going along as they have been until some startling event catalyzes all these ingredients to stop the boom. And such an event could happen next week or next year.
Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned in this post.
