Portfolio Companies Continue Dominance Of ‘Weakest Links’ list

Portfolio companies now account for almost one in every three of the companies identified by Standard & Poor’s as most in danger of debt defaults.

Companies make S&P’s monthly “weakest links” list if they have a speculative corporate credit ratings of ‘B-’ or lower, with either a negative outlook or CreditWatch status. As of Nov. 11, the ratings agency counted 207 entities for the latest report and, from this group, Buyouts has identified at least 63 companies, a little more than 30 percent, as backed by buyout firms. That’s up from 58 companies backed by buyout firms since our last review of the list in September. In total, the list expanded for a ninth consecutive month. See corresponding tables.

Since our last quarterly review of the report, Buyouts has identified 13 new portfolio companies on the list, partly offset by eight that were removed, including four because they went into default. Of the remaining four that were removed, three experienced an improved outlook while one, Monitor Clipper Partners Inc.’s Medical Services Co. unit, left because it requested not to have its debt rated. The defaulters were The Carlyle Group’s Hawaiian Telcom Communications Inc., JLL Partners Inc.’s Motor Coach Industries International Inc., Kohlberg Kravis Roberts & Co.’s Masonite International Inc. and Thomas H. Lee Partners’ American Media Operations Inc. Since Nov. 11, Banc Funds-backed LandAmerica Financial Group Inc. has also defaulted.

The net addition of five buyout-backed companies raised affected debt to $70.8 billion from $47.6 billion three months ago. A significant portion of this increase reflects the inclusion of KKR’s NXP B.V. S&P issued a ‘B-’ rating and a negative outlook in October after the semiconductor maker announced it ended the third quarter with about $1.54 billion in cash after repaying a $450 million revolving credit facility and closing its wireless-chip business. The Dutch company had $11.5 billion in affected debt, according to S&P. On Nov. 20, 2008, the ratings agency downgraded NXP further to ‘CCC’ due to liquidity concerns.

There were three other new buyout-backed newcomers to the list with debt of at least $3 billion, including two of Apollo Management LP’s portfolio companies: Realogy Corp. and Hexion Specialty Chemicals Inc., which had affected debt of about $6.3 billion and $3.5 billion, respectively.

Realogy was downgraded because of thinning cushion in its senior secured leverage covenant. The Parsippany, N.J.-based real estate and relocation-services company has senior secured leverage of 4.9x, less than the covenant of 5.6x in June 2008, according to S&P. However, the ratings agency said the leverage covenant stepped down to 5.35x on Sept. 30, 2008, and will decrease to 5.0x on Sept. 30, 2009. Hexion Specialty Chemicals, meantime, made the list partly due to S&P’s concerns over litigation risk associated with the company’s long-delayed acquisition of Huntsman Corp. Hexion’s ‘B-’ rating and CreditWatch status with a negative implication also reflect weak financial performance. Apollo Management had the highest number of portfolio companies on the list with four.

Warburg Pincus LLC had three investments on the “weakest links” list and all appeared for the first time during the past three months. S&P lowered Titan Petrochemicals Group Ltd. to ‘B-‘ from ‘B’ on Sept. 3, because of weakness in the Hong Kong company’s financials and business risk during the first half of 2008. S&P also questioned the company’s strategic direction. Also Warburg Pincus’s Clearwater, Fla.-based CCS Medical Inc. investment made its debut on the list after its outlook was revised to negative on Aug. 21. The company’s second-quarter financial results were hurt by lower-than-expected growth rates, a major contract loss for its Sanvita glucometer product and increased competition.

S&P also cut Builders FirstSource Inc. to ‘B-’ on Sept. 24, 2008, because the agency expects demand will decline further for the Dallas-based company’s products and services. The supplier and maker of structural and related building products is a portfolio company of both Warburg Pincus and JLL Partners and Warburg Pincus. Its business has been hurt by the economic and housing downturn.

Sun Capital Partners Inc. had three portfolio companies on the list and two are recent additions. S&P downgraded the firm’s Mark IV Industries Inc. affiliate to ‘B-‘ from ‘B’ on Oct. 3 because the maker of automotive systems and components has high leverage and thin cash flow ratios. On Oct. 6, the ratings agency revised its outlook on Exopack Holding Corp. to negative due to liquidity concerns. Exopack faces lower demand and higher resin costs, S&P said.

A Sun Capital spokesman said the companies in question are in challenging industries that will, in all likelihood, experience greater economic pressure over the next few months. (Exopack has about 20 percent of its revenue in building supplies. Indalex is focused on building supplies and truck trailer beds.) He also said each of the respective management teams continues to reduce costs and address market share initiatives, and that the firm is optimistic going forward.

The other firms with at least two investments in the latest report are ABRY Partners LLC, Bain Capital, The Blackstone Group, Bruckmann Rosser Sherrill & Co., Carlyle Group, Cerberus Capital Management, Goldman Sachs through its GS Capital Partners unit, Kelso & Co., KKR and Providence Equity Partners Inc.

The consumer products, media & entertainment and restaurants/retailers sectors continue to constitute a major share of the buyout-backed companies on the “weakest links” list. The consumer products sector had a dozen companies represented in the latest report, while the media and entertainment industry accounted for 11 of the 63 LBO-backed entries. The restaurant and retail segment combined for another 11.

Meantime, S&P has counted 85 defaulters, including 19 confidentially-rated entities, through Nov. 17 and this group had affected debt of $284.39 billion. The 24 entities identified as LBO-backed companies had $21.3 billion in debt (excluding LandAmerica Financial).

Separately, at least 46 portfolio companies have filed for Chapter 11 bankruptcy protection since the start of 2008. Eleven are retailers and 10 operate in the automotive sector. The reasons cited for the various filings include the housing and credit crisis, higher expenses, a drop in sales and liquidity concerns. So far, only five have emerged from the process: Diamond Castle Holdings LLC’s PRC LLC, Patriarch Partners American Lafrance, Clayton, Dubilier & Rice Inc.’s Sirva Inc., Wayzata Investment Partners LLCs Portola Packaging Inc. and Ziff Davis Media Inc., which is backed by Willis Stein & Partners and DLJ Merchant Banking Partners.