Biggest LBOs Remain On Shaky Ground

Recent IPO filings by the likes of Freescale Semiconductor Inc. and HCA Inc. may lead some to conclude that mega-buyouts circa 2005-2007, once at grave risk from the recession, are finally in the clear.That may turn out to be the story. But an article published last month by three credit analysts at ratings agency Standard & Poor’s—Allyn Arden, William Wetreich and Kenneth G. Drucker—suggests many of the largest deals from the golden age of private equity remain at risk of defaulting on their debt obligations. Were the economy to stall, or worse, they could well go belly-up.The authors put 17 of the largest vintage 2005-2007 LBOs under the microscope, examining their pre-LBO credit rating, post-LBO credit rating and current credit rating.

Three of the deals have already had denouements that have removed them from S&P’s ratings categories. They are the sale, agreed to in 2008, of ALLTEL Corp., which produced a healthy return for its sponsors, and the Chapter 11 filings of Tribune Co. in 2008 and Station Casinos Inc. in 2009.None of the remaining 14 companies carries better than a double-B rating, and only two have achieved that—Dollar General Corp. (which Kohlberg Kravis Roberts & Co. took public in 2009) and energy company Kinder Morgan Inc. (which Carlyle Group and Goldman Sachs led to a recent IPO). A double-B rating, according to S&P, suggests a company “faces major ongoing uncertainties and exposure to adverse business, financial, or economic conditions, which could lead to the obligor’s inadequate capacity to meet its financial commitments.”It’s downhill from there. Nine of the remaining 14 issuers, including HCA (B+/Stable outlook), First Data Corp. (B/Stable), and Caesar’s Entertainment Corp. (B-/Stable), fall in the B range, the article found. That means S&P views them as more vulnerable to default than the double-Bs, although they’re not seen as in imminent danger.And three of the remaining 14 issuers bear the dreaded triple-C rating—Energy Future Holdings Corp. (CCC+/Negative), Clear Channel (CCC+/Positive) and Realogy Corp. (CCC/Positive). According to S&P, “an obligor rated ‘CCC’ is currently vulnerable, and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments.”Other findings of the article, “Reshuffling The Debt: The Credit Implications Of The New Wave Of LBOs”: * The most recent wave of LBOs features less leverage, more equity and stronger creditor protections, in general, than the 2005-2007 generation of deals.* Today’s LBOs tend to have less impact on the credit rating of the target companies.

Several of the 2005-2007 vintage LBO targets were investment-grade prior to their buyouts, whereas today’s pre-LBO targets tend to be rated in the B or double-BB camps.