Even highly leveraged companies that were being written off for dead can now borrow to refinance debt
In February 2009, Wall Street was betting that some highly indebted companies taken private by the likes of Blackstone Group (BX), Kohlberg Kravis Roberts (KKR), and other buyout firms weren't going to make it. Credit- default swaps (CDS)—instruments that pay off when borrowers can't meet their obligations—were priced at a level that implied a 99.8 percent chance of debt default for Clear Channel Communications, Univision Communications, Freescale Semiconductor, and the former Harrah's Entertainment (now Caesars Entertainment). The thinking was that with credit markets frozen, those companies would not be able to borrow the money they needed to refinance loans and bonds as they came due.
Two years later, as the economy recovers and access to debt markets opens for even the least creditworthy companies, the story is different. CDS prices on those companies now imply a 47 percent chance of a collapse, according to data compiled by Bloomberg as of Jan 31. The companies' bonds have shown similar improvement: Caesars bonds now trade at 97 cents per dollar of face value, up from 13 cents two years ago.
What happened? As the Federal Reserve holds benchmark interest rates near zero to stimulate the economy, the companies are finding that investors are increasingly willing to lend them money to refinance their buyout-related loans and bonds. "You have a lot of money searching for yield, and when that happens a lot of folks can get money regardless of the situation of their balance sheet and income statement," says Lon Erickson, a money manager who helps oversee $9 billion of fixed-income assets for Thornburg Investment Management in Santa Fe, N.M.
Realogy, a real estate company owned by Leon Black's Apollo Global Management, sold $700 million of bonds yielding 7.875% in January, contributing to the $5.2 billion of sales for the month by companies in Moody's Investor Services' (MCO) lowest tier of credit ratings. For all of 2010, bond sales by low-rated companies totaled $43.7 billion, Bloomberg data show, triple the $14.1 billion issued in 2009. Investors' appetite for junk bonds has led to higher prices—and lower yields. On the bottom tier of junk debt, yields fell to 8.12 percentage points above Treasuries in the week ended Jan. 28, the smallest gap since November 2007, according to Bank of America Merrill Lynch index data. The spread was as high as 44.3 percentage points in December 2008 in the aftermath of Lehman Brothers' bankruptcy.
Some leveraged buyouts still face challenges to refinance debt, including Energy Future Holdings, the largest buyout in history. Natural gas prices slumped following KKR's and TPG Capital's $43.2 billion takeover of the company, then known as TXU, in 2007. CDS prices now imply a 79.4 percent chance of default by Energy Future within five years, figures from market data company CMA show. Lisa Singleton, a spokeswoman for Dallas-based Energy Future, declined to comment.
One reason investors are more confident is that the pace of defaults is slowing. In December the rate of defaults by speculative-grade companies over the previous 12 months was 3.27 percent, down from 11.1 percent at the end of 2009, according to a Jan. 25 report by Standard & Poor's. The rating company predicts that the rate will fall to 2.4 percent by September.
Bond investors are also speculating that LBOs will benefit from the stock-market rally. More than half of the initial public offerings planned in the U.S. for this year were from private equity firms as of the start of this year, Bloomberg data show. When they sell stock to the public, companies are able to use the proceeds to retire debt.
Nielsen Holdings (NLSN), the television-rating company owned by Blackstone, Carlyle Group, KKR, and Thomas H. Lee Partners, raised $1.89 billion on Jan. 26 in the biggest private equity-backed U.S. IPO. "You may see a stronger IPO market this year than you've seen in the last couple of years," says Hans Mikkelsen, an analyst at Bank of America. Issuing equity is "really a prerequisite for a lot of these companies to improve their capital structure."
With previous buyouts back from the dead, the world's largest private equity funds are planning a new round of takeovers. KKR is seeking to raise $8 billion to $10 billion for a new fund. In an interview with Bloomberg TV at the World Economic Forum in Davos, Switzerland, Blackstone co-founder Stephen A. Schwarzman said that there is capital to fund leveraged buyouts of as much as $10 billion as debt becomes more available.
"We're all absolutely shocked at how fast leverage snapped back from where we were, say, two years ago," says William G. Welnhofer, a managing director at Robert W. Baird & Co. in Chicago. "I don't think anyone who's honest would have expected such a move."
The bottom line: Investors willing to go out on a limb for higher yields are helping heavily indebted companies refinance their loans and bonds.