Twenty-two Portfolio Companies Join ‘Weakest Links’ List

Portfolio companies continue to account for a high percentage of troubled companies, according to the Standard & Poor’s latest “weakest links” report.

By our count, the number of weakest-link companies with U.S. buyout sponsors rose by 12, to 58, since our last review of the report three months ago. While 10 portfolio companies dropped off the list for reasons that include improved performance and one default (Residential Capital LLC), 22 joined the list during that time. The 58 with buyout sponsors represented affected debt of about $47.6 billion. By comparison, we identified 46 LBO-backed companies with a combined debt of $26.5 billion on the S&P weakest links list in May.

Companies make the S&P list if they have a speculative corporate credit rating of ‘B-’ or lower, along with a negative outlook or negative CreditWatch status. Altogether as of Aug. 11, the ratings agency described 156 entities around the world, with combined debt of at least $352 billion, as weakest links.

Portfolio companies in the automotive sector saw a turn for the worse in the quarter in the eyes of S&P. Specifically, two Cerberus Capital Management LP investments, Chrysler LLC (Chrysler Holdings LLC) and DaimlerChrysler Financial Services LLC, joined the weakest-links list in August with affected debt of $9 billion and $6 billion, respectively.

S&P cut its rating on Chrysler LLC and the auto maker’s financing arm DaimlerChrysler Financial Services Americas LLC on Aug. 7 to ‘CCC+’ from ‘B-’ partly on the deterioration in the domestic market for vehicles. “The greatest threats to the ratings in the near term are the depth of economic weakness in the U.S., the extent of the demand shift away from light trucks, and the ability of the finance company to continue its timely access to the asset-backed securities markets in support of Chrysler’s sales,” the ratings agency said.

Meantime, companies in consumer products, media & entertainment and restaurants/retailers continued to dominate the S&P weakest-links list. The consumer products sector accounted for 11 of the LBO-backed companies, media and entertainment 10 and restaurants/retailers nine in the August 11 tally. Just these three sectors represented more than half of the 58 companies with LBO sponsors.

Carlyle In Front

With the downgrade of Oriental Trading Co. to ‘CCC+’ on Aug. 8, Carlyle Group LLC became the sponsor with the most number of investments in the S&P weakest links list, with four. The Omaha, Neb.-based party supplies retailer could end up breaching financial covenants because of weak operating trends, according to the ratings agency. Oriental Trading’s EBITDA margin has come down to 13.9 percent for the trailing 12 months ended June 21, down from about 15.4 percent a year earlier, the rating agency added.

The other firms with at least two portfolio companies on the latest report are ABRY Partners LLC, Apollo Management LP, Bain Capital Inc., Bruckmann Rosser Sherrill & Co., Cerberus Capital, Fenway Partners LLC, Goldman Sachs & Co. through its GS Capital Partners unit, Kohlberg Kravis Roberts & Co., Providence Equity Partners Inc. and Thomas H. Lee Partners.

Two additions, both restaurant companies, made returns to the list. Trimaran Capital Partners’s El Pollo Loco Inc. is back after S&P changed its outlook on the Irvine, Calif.-based company to negative on July 3, 2008. “The outlook revision reflects our analysis that the company will have a difficult time complying with financial covenants of its senior secured credit facility in the coming quarters as they become more restrictive,” S&P said.

The other returning portfoli company is Castle Harlan Inc.’s Perkins & Marie Callender’s Inc. The portfolio company’s outlook was revised to negative by S&P on June 5, 2008, because of the Memphis, Tenn.-based company’s deteriorating performance. Perkins & Marie has leverage of more than 9x and EBITDA interest coverage of less than 1x, according to the ratings agency, which doesn’t expect Perkins & Marie to comply with financial covenants if performance continues to decrease.

S&P also reported a rise in the number of defaults during the quarter. Through Aug. 11, the ratings agency had identified 52 defaulters (including 11 confidentially rated companies) with affected debt of $41.3 billion. Of those, Buyouts has identified at least 19 with LBO sponsors, including Cerberus Capital’s Residential Capital unit, Investcorp’s GWLS Holdings Inc. and Madison Dearborn Partners LLC’s Pierre Foods Inc. investment.

Since S&P’s weakest-links list was published last month, the ratings agency has already changed the ratings or outlook on several portfolio companies. On the bright side, Fenway Partners’s Coach America Holdings Inc. saw its outlook revised to stable on Aug, 20. “The outlook revision is based on Coach America’s recent improvement in operating performance and our view that these gains will be sustained over the next year,” S&P said.

On the other hand, the rating on Carlyle Group’s Hawaiian Telcom Communications Inc. investment was lowered further on Aug. 19 to ‘CCC+’ because of S&P’s view that the portfolio company’s liquidity will be insufficient to service debt and fund operations through 2009. Metalmark Capital LLC’s Tegrant Corp. unit saw its S&P rating lowered further to ‘CCC’ on Aug. 26 due to weaker-than-expected operating performance. The ratings agency also cited Tegrant’s highly leveraged financial profile and liquidity concerns. S&P also lowered its rating on Centre Partners Management LLC’s Uno Restaurants Holdings Corp. investment on Aug. 18 to default because of a missed interest payment on a senior secured second-lien notes due in 2011.