Serial Defaults Often Have PE Involvement

More than half of companies identified recently as multiple defaulters by Standard & Poor’s have been linked to alternative investors, such as buyout funds.

“An enormous debt load, often resulting from multiple acquisitions, was a huge financial risk factor we frequently observed,” S&P reported. “A number of serial defaulters in our dataset underwent leveraged buyouts in the 1980s, which caused their financial risk to balloon and ultimately led to the companies’ defaulting.”

Still, the links are sometimes more tenuous than they might appear at first glance. In some cases, the sponsors were in fact rescuers of companies that got into trouble on their own, while in some others, the private equity investments were in industries that already were facing their own secular problems.

Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill Cos. Inc., published its report, “Til Debt Do Us Part: A Study Of Serial Defaulters,” this month, identifying 99 companies, in a database dating from 1981, that have defaulted on their loan obligations more than once in their lifetimes. With 1,831 companies in the database that recorded a default, those 99 represented about 5.4 percent of the total defaulters. S&P went on to note that 90 of the 99 defaulted twice and nine defaulted three times.

Of those 99, 55 of the issuers, or 57 percent, were linked with alternative investors—among them buyout funds, hedge funds, special situations funds and REITs. “This is perhaps not surprising because traditional funding sources usually dry up as distress increases, making room for alternative investors,” S&P noted.

Of the 55 companies linked with alternative investors, 47 had two defaults and seven had three.

To review S&P’s findings, Buyouts went through its own screen of the 99 multiple defaulters, finding 33 that had ties to private equity firms, as opposed to hedge funds, REITs or other types of investor. Within our universe, 27 of the 33 had two defaults and six had three.

Viewed another way, 76 buyout firms, venture capital firms and institutional co-investors had ties to those 33 portfolio companies, either in consortium investments or sponsor-to-sponsor handoffs. Thomas H. Lee Partners LP had, by far, the most ties to serial defaulters, with five such connections. Four other firms had three such connections, and six firms had two.

To be sure, it is easy enough to find examples that confirm S&P’s thesis. The gambling and entertainment company Harrah’s Entertainment Inc.—taken private in January 2008 by Apollo Management and TPG in a $27.4 billion deal, one of the largest ever—defaulted first in December 2008 and again in July 2009.

Likewise, Clear Channel Communications Inc.—taken private in July 2008 by a consortium that included Bain Capital Partners LLC and Thomas H. Lee Partners, in a $25.9 billion deal—defaulted in December 2008 and again in August 2009.

Other cases paint a different picture of companies and their problems. American Restaurant Group Inc., a chain of steakhouses based in Los Altos, Calif., had defaulted twice before, in 1997 and 2004, before Versa Capital Management bought the company at the end of 2008 to bring it out of bankruptcy. Versa later exited the investment, according to Thomson Reuters, and the company is once again independent.

Or consider the case of Ziff Davis Media Inc., a publisher covering high technology that defaulted in July 2002 in the wake of the dot-com meltdown and again in March 2008 as the economy once again slumped into recession. A management- led investor group, including Vivek Shah and Great Hill Partners LLC, acquired Ziff Davis in June with the stated purpose to “build an exciting new digital media company focused on delivering fantastic content to audience and unprecedented opportunities to marketers,” according to Thomson Reuters. Although Ziff Davis had struggled under a series of buyout owners, including Willis Stein & Partners, and although other print-oriented publishers also have suffered with the shift to electronic media, this deal seems to show that hope springs eternal.