Wednesday, November 01, 2006

LBOs are to corporate balance sheets as fast foods are to slim bodies

An LBO ("leveraged buy out") is a takeover of a company by a group that then uses the company's assets and creditworthiness to load the company up with debt, pay the takeover group a heap from the borrowed money, then, typically, offload the debt-bloated company back onto the market. It's asset stripping through the debt back door.

You'd think the market would know better, but since most of the buyers on the market are fund managers that simply seem compelled to put your money to work come what may, nobody really cares much about the bloat. They just don't care. See, Time to probe the investing fee greed.

Buyout Firms Punish Bondholders by Gorging on Record Dividends
By John Glover and Cecile Gutscher

Bondholders worldwide are suffering a double whammy this year because more than 80 companies controlled by LBO firms have borrowed at the expense of workers and debt investors just so they can pay themselves dividends, according to data compiled by Bloomberg and Standard & Poor's.

"Hedge funds and credit funds like the return and can make a judgment with respect to the company's equity value," said Eric Capp, head of European high-yield capital markets at JPMorgan Chase & Co. in London, which arranged the bond sales that paid the dividends by Brake Bros and Impress. "As long as they're feeling confident the debt will eventually be refinanced with an exit, they're willing to buy it."

Firms such as New York-based Blackstone Group LP and Kohlberg Kravis Roberts & Co. completed $269 billion of LBOs this year by borrowing at least $166 billion in loans and bonds, according to Bloomberg and Lehman Brothers Holdings Inc. data.

Companies owned by the LBO groups sold an additional $30 billion of debt this year for dividends, said S&P. The payments have helped the firms recoup 86 percent of their investments within two years, according to Fitch Ratings.

LBO firms, which typically borrow two-thirds of the money they pay for acquisitions, used to wait three to five years before profiting from selling shares in their companies.

The debt of companies owned by buyout firms has risen to the equivalent to 5.4 times their cash flow, the most ever, S&P says. Debt rated below BBB- by S&P and Baa3 by Moody's Investors Service is considered non-investment grade, or junk.

Payouts to buyout firms were partly to blame for the lagging performance of bonds sold by Hertz Corp., Brake Bros Plc and Impress Holdings BV. Their bonds trailed the 8 percent average return this year for securities with junk ratings, costing holders about $70 million in total, according to U.S. indexes compiled by Merrill Lynch & Co.

Hertz pummeled bondholders after the rental-car company said in September 2005 it was being acquired for $15 billion. Its $175 million of 7.625 percent notes due 2012 lost as much as 10 percent of their face value. S&P cut the ratings on the Park Ridge, New Jersey-based company to BB- from BBB-.

Just six months after the buyout, Hertz used a $1 billion loan to pay a dividend to its new owners, Clayton Dubilier & Rice Inc., Merrill Lynch and Carlyle Group, and S&P threatened another ratings downgrade.

The company plans to reduce debt and pay its owners another dividend, this time $427 million, when it raises as much as $1.83 billion in an initial public offering, Hertz said last week in a filing with the U.S. Securities and Exchange Commission.

"Any time you replace equity with debt, that's bad for the credit," said Steven Bavaria, head of loan and recovery ratings at S&P in New York. "You're bound to see an increase in the risk of default."

After Weetabix Ltd., the maker of Britain's best-selling breakfast cereal, fired 7 percent of its workers and canceled the employee bus service to free up cash for debt from a leveraged buyout, the Kettering, England-based company borrowed 130 million pounds ($249 million) so it could enrich owner Lion Capital.

Weetabix will pay annual interest of 13 percent for the next decade because of the dividend to Lion Capital. That's almost double the cost on loans it used earlier this year to refinance debt from its 2004 buyout, Bloomberg data show. Interest costs like those may force the company to cut more expenses.

When Paris-based cable television company Numericable SA borrowed 500 million euros ($635 million) to pay dividends to London-based buyout firm Cinven Ltd. in July, investors required interest of 9.125 percentage points more than the euro interbank offered rate, a lending benchmark. That was about 2 percentage points above the average for comparable notes, according to Credit Suisse Group data.

Brake Bros, the Ashford, England-based food distributor, sold 275 million pounds of bonds in September to pay a dividend to Clayton Dubilier. The securities yield about 12.95 percent, or 7.75 percentage points more than the London interbank offered rate.

S&P cut Brake Bros' ranking to CCC+. Bonds with that rating are "vulnerable to nonpayment," S&P says. Clayton Dubilier partner and Brake Bros Chairman Bruno Deschamps declined to be interviewed.

"They're choosing to pay out a dividend, add more leverage and forestall what's typically a good event for bondholders in an IPO," said Paul Scanlon, managing director for U.S. high-yield and bank loan assets at Putnam Investments in Boston, which owns Hertz bonds in its $62 billion of funds. "Any excess cash for paying down debt or reinvesting in the business isn't going to happen."

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