There's Still Life In The Old LboJudith H. Dobrzynski
Banks have all but pulled out of leveraged-buyout loans. Junk-bond investors, already trying to pare back their holdings in the many deals that have gone sour, want no part of new deals. Insurance companies and other financial institutions have turned supercautious and very selective. No wonder LBOs are in the dumps (chart). Who's going to pony up the money?
IBM, General Electric, Delta Air Lines, and Texas Instruments, to name a few. On Jan. 10, buyout sponsor Forstmann Little & Co. said it had raised some $1.4 billion of new subordinated-debt money, largely from corporate pension funds. And Forstmann did it lickety-split: Senior partner Theodore J. Forstmann started seeking the money in late September and had most of his commitments lined up before Christmas. Rival Kohlberg Kravis Roberts & Co., meanwhile, set out last fall to add $1 billion to $2 billion in new equity funds to its $1.6 billion hoard. So far, it has won promises for about $750 million, mostly from state pension funds in Oregon and Washington. KKR expects to reach at least $1 billion in the next few months.
ON THE PROWL. In the eyes of some LBO firms and investors, the buyout market may be turning: 1991 could see an upswing in deals, at least in the second half. "Now is a good time to buy, unless you think the `90s are going to be a decade of disaster," says one LBO sponsor. Joseph L. Rice III, president of sponsor Clayton & Dubilier, agrees: "We'll be as active as we know how to be in `91." Others on the prowl: Leonard Green & Partners, Kelso, and Merrill Lynch Capital Partners. Even Adler & Shaykin, whose Best Products Co. buyout just filed for bankruptcy protection, says it plans to do a deal this year.
No one is predicting a return to the heyday of the late `80s, though. For one thing, in today's harsh deal environment, the number of players has dwindled. "Some have either run out of money, or they've run out of credibility," notes Leonard Green. These include some Wall Street firms, such as First Boston Corp., and Green's old partners at what is now called Gibbons, Goodwin, van Amerongen, from whom he split in 1989. GGvA, having exhausted its equity fund, plans to focus on managing the 10 companies it owns, perhaps adding to them by acquisition.
Prices also are dampening activity, especially since new tax rules have cut off some benefits for LBOs. Dealmakers complain that although stock prices have fallen and the economy is in a recession, companies still are seeking `88 or `89 prices for divestitures. KKR and Merrill Lynch are among the LBO firms that tried to buy properties during 1990, only to be turned down on price. "There's still a big gap between the seller's expectations and the buyer's expectations," says Merrill's James J. Burke Jr., who has $1 billion in equity capital to invest.
The biggest impediment, though, is financing--or lack thereof. Banks want to lend for LBOs, which despite soured deals are a good business and generate big fees. But they face regulatory pressure to build their capital bases, which may mean shrinking their assets, especially risky loans. Many insist they're still doing deals--and will do more. "Once the Mideast is resolved, you'll go back to the case where well-structured deals with well-known buyers will continue to get financing," says Todd Slotkin, the senior managing director who oversees Citibank's buyout loans.
HIGH HOPES. If so, the deals will be smaller--megadeals simply can't be financed. And terms will change: Banks want to see equity at 25% or more of capital, vs. 10% or less in the past. They also want operating cash flow to cover interest costs by a factor of two, vs. one or less in the go-go years. Deals that depend on asset sales are nonstarters.
Without a viable junk market, "mezzanine" money--the layer of capital that ranks below senior secured debt--remains problematic. Some institutions say they'll still invest in buyouts, via private placements, as long as sponsors boost their equity in a deal to 25% or more. But LBO firms maintain that these lenders haven't lowered their return expectations to realistic levels--most likely percentages in the mid-teens. So LBO veterans forecast that some transactions will be financed entirely by equity and senior bank debt. Kelso already has completed one such deal. KKR has also contemplated that maneuver as a temporary measure until mezzanine funds are available.
It's this climate that allows Forstmann, who did two deals in 1990, to claim a leg up: Only he has both equity and subordinated-debt funds. His new fund carries an interest rate of one percentage point above the five-year Treasury-bill rate, which is now 7 3/4%. With $2.1 billion in mezzanine money and $700 million in equity funds, Forstmann could be busy in 1991. The financial climate willing, other established LBO firms hope to be, too.