Lousy debt market threatens buyout industry

It may seem like the carried interest tax proposal is the only story some of your cohorts are concerned as they surf the blogs (see story, page 1), but there are other issues that industry pros should not neglect.

In fact, a far more significant story is perhaps developing as buyout firms are facing a growing difficulty with having to sell bonds related to their acquisitions.

In a story in the Wall Street Journal last week, underwriters have reportedly pulled a bond sale by U.S. Foodservice, which agreed earlier this year to be bought by Clayton Dubilier & Rice and Kohlberg Kravis Roberts & Co. for $7.1 billion. The sale and other loans backing the deal have been postponed due to weak market conditions, the Wall Street Journal reported.

The Journal maintains that several factors form the basis for this pushback against these kinds of buyout financings. One is the growing awareness that investors have been demanding very little in return for the risk they have accumulated in snapping up buyout-related loans and debt. Indeed, the yields on junk bonds, when compared with U.S. Treasury securities dropped to record lows in May. And the near-collapse of two Bear Stearns hedge funds that invest in risky subprime-mortgage debt also has sparked broader investment worries in the PE industry about risky investments.

Another example of the signs of peril is Dollar General Corp., which was expected to begin selling bonds related to its buyout purchase late last week. KKR bought the discount retailer in March in a deal valued at $7.3 billion. Banks handling the Dollar General deal had intended to sell investors $2.4 billion in loans and an additional $1.9 billion in junk bonds with provisions that give the company leeway if it struggles.

If buyers of bonds—who are usually institutional investors, such as mutual funds, pension funds, hedge funds and endowments—start to turn against these borrowings, it could slow, if not derail, the buyout boom, which saw $395 billion worth of deals in the United States last year, according to Thomson Financial (publisher of PE Week). Already this year, the total value of private equity deals has reached $308 billion.

“Clearly concerns are spreading,” one analyst told CNNMoney.com. “More deals are getting priced at much higher levels or aren’t getting done at their initially proposed terms. I think we’re starting to see the market turn for high-yield debt offerings.” —Alastair Goldfisher