Jumbo LBO Deals Fared Badly, Says Moody’s Report

Leveraged buyouts struck by Cerberus Capital and Apollo Management are performing worse than deals by other private equity firms such as Kohlberg Kravis Roberts & Co., a report by Moody’s said earlier this month.

Moreover, mega-deals have fared badly on average, said the report, which studied 186 deals structured during the 2004-7 bubble period. Moody’s picked deals on the basis that they were investments made by the largest private equity firms; had a rating by Moody’s during the period January 2008 to October 2009, and were financed or structured in the 2004-7 time frame.

The findings showed that roughly two-thirds (65 percent) of Apollo’s deals surveyed and of Cerberus’s (67 percent) were classified as either in default or distress. Moody’s counts debt-for-debt and debt-for-equity swaps as a default, as well as the repurchase of a significant portion of the company’s debt through open-market repurchases. It notes in the report that not all investors would consider all of those categories as a default.

On the other side of the ledger, just 15 percent of KKR’s deals surveyed were classed as defaulted or distressed. Others with lower default and distress rates—all in the 20 percent to 30 percent range—are The Blackstone Group, JPMorgan’s private equity unit, and Madison Dearborn Partners, the report said.

Private equity firm Welsh Carson Anderson & Stowe had zero defaults on its deals, the report said, although 31 percent were classified as distressed. “It is crucial to remember that private equity firms are not all alike, and that their philosophies differ to some extent,” Moody’s Senior Vice President John Rogers wrote in the report. “Some are more mindful of the potential impact that distressed debt holders could have on future financings, while others focus primarily on equity returns.”

The report does not look into returns on individual deals or funds, and it is quite possible for private equity firms to make money on individual deals even if they are distressed.

Size Matters

The bigger deals struck during the boom period have fared badly, the report says, such as Cerberus’s Chrysler Automotive, which went into bankruptcy and later re-emerged. Indeed, the top 10 private equity-sponsored LBOs by transaction value performed much worse than other private equity deals or similarly rated companies, Moody’s concluded.

Among some of Apollo’s deals, retailer Linens ‘n Things filed for bankruptcy protection as sales slumped, casino owner Harrah’s has struggled with its debt load and real estate brokerage Realogy has had to deal with the gloomy real estate market.

But the report did conclude that when two or more of the largest firms collaborate on a deal—a so-called “club deal”—the deals tend to have a lower default rate.

Private equity firms that bought companies with high levels of debt during the boom years are also facing the problem of refinancing that debt in the coming years. “Current market conditions, while greatly improved over the past six months, could not support the magnitude of debt that must be refinanced over the next five years,” Rogers wrote.

Without a substantial improvement in the high-yield markets, he writes, many companies could have trouble refinancing their debt. Those that do may be forced to pay significantly higher interest rates, “which may compromise their financial viability,” he wrote.

— Megan Davies is a New York-based correspondent for Reuters.