bloggingbuyouts

The Wall Street Journal [subscription required] reports that Kohlberg, Kravis and Roberts (KKR) is negotiating with banks to lend it $24 billion for its $26.4 billion deal to buy payment processor, First Data Corp. (NYSE: FDC). What's at stake here is whether last month's pause in the private equity fueled takeover market is temporarily on hold or dead for a decade.

There is a $400 billion backlog of such debt deals in the pipeline. Prior to the August pause, banks had no trouble selling the debt to hedge funds and others. But the terms -- or covenants -- of that debt were so loose that the banks were creating loans that demanded very little in the way of performance.

These so-called covenant-lite loans may soon become a thing of the past. If the Journal's reporting is correct, KKR may agree to a covenant requiring it to maintain a minimum level of earnings before interest taxes depreciation and amortization (EBITDA). Such terms used to be common in debt offerings, but the fact that there is even any debate about it, indicates how much covenant-lite debt risk is currently out in the market for which debt buyers have no protection at all.

The fees at stake for this deal are absolutely outrageous. If KKR completes this takeover, it stands to pocket $300 million in fees from First Data for getting the deal done. At the same time, KKR is paying the banks $500 million to $600 million in fees to finance the deal.

So if KKR can put enough covenants into its First Data financing to get its deal done and enable the banks to sell the debt to investors, then perhaps the private equity boom can continue. Unfortunately for KKR and its peers, the investment banks have already given up and are shuttering the prime brokerage units that arrange hedge funds' borrowing lines. Without the borrowing facilities, investor's demand is likely to fall far short of supply.

The same dynamic is true for managers of what are known as collateralized loan obligations (CLOs). These managers buy up pieces of loans that come along, combine them and then sell slices that have higher credit ratings. This market, which depends on the extensive use of borrowed money, has slowed markedly. With little leverage now available, it's not clear where the money will come from to absorb all that debt.

The market for buyout debt is already fragile, if KKR cannot agree on terms with its banks, the impact on investors could be devastating.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter













The Cohan Letter.