Portfolio Troubles Continue To Mount

Sometimes the tip of the iceberg looks fairly sizeable in its own right.

Both Standard & Poor’s and Moody’s Investors Services have been issuing downgrades of buyout-backed companies at a rapid clip. Many of these downgrades, like that of Greatwide Logistics Services, a Dallas-based transportation and logistics company, take the companies deeper into speculative-grade territory.

Meantime, S&P, believing that “the seeds of the next stage of the credit cycle have been sowed,” last month projected that the U.S. high-yield bond default rate would more than double over the next year, to 3.4 percent. Hitting that target would require 56 issuers to default during that time, and a good portion of those would almost certainly be owned by buyout shops. Consider that at least 29 of the 89 companies on S&P’s August “Weakest Links” list—those deemed most at risk of defaulting—are portfolio companies.

In recent issues, Buyouts has made a close inspection of three companies producing unnerving results for creditors—Buffets Inc., owned by Caxton-Iseman Capital and Sentinel Capital Partners (Oct. 22 edition); Freescale Semiconductor Inc., owned by The Blackstone Group, The Carlyle Group, Permira and TPG (June 11); and Spectrum Brands, in which Thomas H. Lee Partners holds a minority stake (this issue, page ). Below is a brief rundown of four others believed to be still owned by buyout shops. To be sure, these companies may avoid defaulting. Also, their recent performance doesn’t necessarily reflect poorly on their owners, who may make a specialty of turning around underachievers. And finally, their owners may have already recovered some or all of their original investments back.

• Airborne Health: In late September, S&P reported that this Bonita Springs, Fla.-based maker of dietary supplements had secured a waiver from creditors after violating its total leverage and interest coverage covenants under a bank credit agreement. Summit Partners acquired the company in 2005, launched a $180 million recapitalization the following year, and put the company up for sale earlier this year, according to TheDeal.com. It is still listed as an active portfolio company on the Summit Partners Web site. At the time of its report, S&P affirmed a CCC+ corporate credit rating on Airborne Health, suggesting vulnerability to default, but subsequently notched it up to B-.

• Greatwide Logistics: Early last month, Moody’s hit this Dallas-based provider of transportation services and logistics with a downgrade on its corporate family rating from B3 to Caa1. The ratings agency in part cited “earnings and cash flows well below the levels anticipated at the time of the acquisition” by Investcorp and Hicks Holdings LLC. The pair acquired the company late last year for $730 million from Fenway Partners, which retained a minority stake after scoring a big return on its money. I was unable to reach an executive at Investcorp or Hicks Holdings for comment.

• IAP Worldwide Services: Moody’s late last month downgraded this defense contractor’s corporate family rating from B3 to Caa1 after the company said that it had defaulted on its interest coverage and leverage covenants. At least as of this summer, Cape Canaveral, Fla.-based IAP Worldwide Services was owned by New York hedge fund Cerberus Capital Management LP, a specialist in turnarounds. Cerberus owned the company since at least early 2005, when it completed the add-on acquisition of Johnson Controls World Services to build a company with annual sales of more than $1 billion. I was unable to reach an executive at Cerberus for comment.

• Leiner Health Products: This Carson, Calif.-based maker of vitamins and nutritional supplements got hit with a corporate family downgrade to Caa3 from Caa2 by Moody’s in late September. The ratings agency said it was growing leery of the company’s ability to retain customers following allegations by the Food & Drug Administration that the company falsified records related to quality testing. (The company suspended the manufacture and distribution of its over-the-counter products in March, but late last month the FDA gave the company permission to re-start distribution so long as an independent firm verified quality.) The company is listed as a portfolio company on the Web sites of Golden Gate Capital and North Castle Partners. The pair led a $650 million recapitalization of the company in early 2004. Through the recap Golden Gate invested for the first time, and North Castle scored a 3x return on its 1997 investment while maintaining a stake in the company. A spokesperson for North Castle declined comment, and a spokesperson for Golden Gate also declined comment.