It’s not unusual to hear a buyout pro boast of never having sustained a loss while pursuing a particular investment strategy. I’m guessing that claim will become a lot harder to make in the months ahead.
The last couple of weeks saw bankruptcy filings by at least three buyout-backed consumer products companies—
In addition, companies backed by LBO firms routinely make appearances on lists of distressed companies and of those defaulting on their debt obligations, whether or not they file for bankruptcy. Of 22 Standard & Poor’s-tracked companies around the world that defaulted on their obligations last year, Buyouts counts nine, or just over four in 10, that had financial sponsors behind them at the time of the default.
Through June 11 of this year, S&P clocked in yet another 33 defaulters—earning them the un-coveted “D” rating—as the slowing economy and credit crunch began to take their toll on the fiscally limp. Again, portfolio companies were well represented. By our count, buyout firms owned or had investments in fourteen of those 33 “D”-rated companies at the time of default, or just over four in 10.
And what of the months ahead, a time that both S&P and Moody’s Investors Service predict will be one of growing defaults? Buyouts identified buyout backers for 46 of 130 companies, or just over one in three, labeled “Weakest Links” by S&P in a report published this May (Buyouts, June 23); those making the list were deemed most at risk of default out of all rated companies located anywhere in the world.
Last month, the ratings agency also released a separate report taking a close look at three of the weakest sectors of the U.S. economy—consumer products, media and entertainment, and retail/restaurants. The fortunes of all three rely heavily on spending by consumers, who have grown stingy due in part to high gas prices and falling home prices.
All told, 223 companies in these three sectors were called out in the report for having “credit stress.” They either command a spot on the “Weakest Links” list; have debt securities trading in excess of 1,000 basis points above U.S. Treasuries (earning them the adjective “distressed” from S&P); or have their debt tagged with a negative outlook, making them susceptible to a bond downgrade. Of those 223, Buyouts identified 56 backed by buyout shops, or roughly one in four. Three buyout shops have four or more companies on that list:
S&P last month predicted that the U.S. speculative-grade default rate would reach 4.7 percent over the next 12 months. To get there would require 73 more issuers to default during that time. However, the ratings agency also calculated both “optimistic” and “pessimistic” scenarios, each with a 20 percent probability. It would take 58 defaults during that time to produce the optimistic rate of 3.7 percent, and 133 defaults to reach the more pessimistic rate of 8.5 percent, according to the report. How many of these defaulting companies will be backed by buyout shops?
Based on the analysis above, one would reasonably expect portfolio companies to comprise anywhere from one in four to one in three of these defaulters. However, that portfolio companies are especially well represented among actual defaulters over the last year suggests a troubling possibility. Stressed portfolio companies may actually be more likely to succumb to default than stressed companies not owned by buyout shops.
Count on us to keep an eye out for whether that trend continues in the months ahead.