bloggingbuyouts

Banks that are lending capital to private equity firms for leveraged buyouts may have a new excuse for the "non-funding" of commitments: their legal departments. The Financial Times reports that legal advisors to banks are starting to advise banks that it may be cheaper for them to not fund these large private equity loans, even if they have to pay a penalty or have to take a hit from a break-up fee.

In an environment where banks have to write-down loans, write-off certain CDOs, and actually have to fight for survival, this may not be too much of a shocker. According to this report, attorneys said that the break-up fees resulting from ending those commitments would be less than the write-downs related to those loans. Imagine that. Attorneys advising clients to walk away from their contracts.

It's no secret that the days of the new giant club deals are done for the foreseeable future. But there is apparently a new reason that takeover targets can demand either tighter terms or higher break-up fees when private equity buyers come knocking.

Jon Ogg is a partner and editor in 247WallSt.com.

You think subprime is a mess? We may have another big-time problem -- the leveraged buyout (LBO) binge. This week's Barron's [a paid publication] has a good piece on the matter.

Private equity firms tend to focus on mature companies, which produce lots of cash flows. There is usually a good amount of cost-cutting as well. But for the private equity firms to make real money, they need to pile on the debt. This is fine -- so long as there is enough cash flow.

Unfortunately, it looks like the U.S. economy is slowing down. As a result, some LBO deals may fall apart because they can't meet debt payments.

Wall Street is already getting nervous. For example, Barron's points out the sluggish bond prices for companies like Realogy, Swift Transportation, Linens 'n Things, Claire's Stores and Dollar General. Some buyout deals are even trading at about 50 cents on the dollar.

All in all, we may see wipe-outs of the equity stakes for private equity firms. It's a good bet that the returns -- for 2008 to 2009 -- will pale in comparison to the boom times.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Edgar Online Guide to Decoding Financial Statements. He also operates DealProfiles.com.

There's been a lot of talk lately about whether the decline of the buyout boom will lead to a weakening of the public markets. The Wall Street Journal summed up the argument that it would pretty well:

For the past few years, private-equity firms have helped to lead the stock market higher by offering rich premiums for the shares of companies they were seeking to take private.

This important underpinning to the market might now be losing its power. As the cost of financing rises, private-equity firms will lower the price they are willing to pay -- if they buy at all.

But the Financial Times ain't buyin' it:

Private Equity Intelligence provides an estimate for "dry powder" - committed equity as yet unspent - for buy-out funds. To this can be added the likely capital raised by private equity outfits on the road now to produce a total of $548bn... It is reasonable to assume that this money is spent on takeovers that are three-quarters debt-financed and occur at a one-third premium to the stock market price... On this basis the total LBO takeover premium due to be paid to stock market investors is $506bn. This is only 2 per cent of North American and European market capitalisation... if investors are accurately discounting the immediate pipeline of activity, anticipated LBO takeover premiums are not heavily distorting equity prices in aggregate.

To me, that's actually pretty compelling evidence that a downturn would harm equity markets -- If the "dry powder" dries, we would, based on the theory provided in the article, see a buyer of 2% of the U.S. and European market's stock fall off the face of the earth. That's the equivalent of 4 Berkshire Hathaway's saying the heck with it.

We'll see what happens, but I think a downturn in the private equity industry will have a materially adverse effect on the stock market's performance.

Readers of my recent posts have repeatedly heard my warnings that private equity is going to begin having much more difficulty borrowing capital to complete leveraged buyouts. While this is certainly not an eclectic or overly contrarian idea, there are still many private equity perma-bulls on the street.

The New York Times is reporting on the debt markets "squeezing" private equity. According to the article, high yield borrowers are demanding higher interest rates on their loans. In my opinion, this is a very fair stance because the credit markets are in no way pricing in the potential risk that lies within.

If private equity firms are forced to pay higher interest rates for capital its entire model for the buyout is flawed, because the cost of capital is imperative to coming up with a valuation, especially for funds who plan on loading the company with debt. Many have rightly speculated that the private equity boom of the last several years was primarily the result of low borrowing costs.

The primary companies at risk in this type of environment are the banks providing bridge loans to these private equity firms. Basically, a bridge loan is a loan granted in the interim while the bank tries to raise capital for the company or sell this loan to another person. But in this environment of increased skepticism towards the whole private equity complex, banks are stuck holding these loans on their balance sheet as they can't find investors interested in buying the loan.

I recently was in the office of a high yield-focused hedge fund. According to the people I spoke to, hedge funds are in fact becoming much more hesitant to lend money in the lower-end of the credit structure. But many people are beginning to get very interested in the bank debt of private equity companies because the LBO would have to be a total failure for this debt to default. Interestingly, despite the fact that the bank debt is so high on the capital structure, many of these securities are trading below par.

Goldman Sachs Group Inc. (NYSE:GS) is planning to raise $19 billion to $20 billion for the largest corporate buyout fund ever.

This isn't a total shock. As Reuters points out, rival bankers have argued that Goldman was excluded from the Blackstone Group IPO because it's viewed as too much of a competitor. Goldman Chief Executive Lloyd Blankfein disputes this characterization.

Last month, Goldman joined forces with Kohlberg Kravis Roberts & Co. and Texas Pacific Group for the $45 billion TXU buyout, the largest ever.

Buyout funds are surging in popularity because of the growing demand by large investors for alternatives to stocks and bonds

But this is far from a sure thing.

``They have been leaders in identifying new trends and clearly this is where they feel their profit margins have the most growth opportunity,'' said Financial Advisory Service portfolio manager Douglas Ciocca told Bloomberg News. ``But this is risky if it decreases their liquidity.''

It will be interesting to watch to see how private equity firms and rivals on Wall Street react to Goldman's move.

Meanwhile, I bet hotel rooms are booking up fast near Goldman's headquarters in New York from companies both large and small eager to be acquired.