Sallie's Suitors Get Cold Feet

News that the J.C. Flowers-led group may pull out of its deal to buy the student-loan outfit pressured shares of its parent Wednesday

Could it be a broken engagement for Sallie Mae? The company's deal with a group that said it would buy the student-loan provider in April may end prematurely.

Voicing concerns with proposed legislation that would cut into the student loan provider's margins, a group of buyers led by private equity firm J.C. Flowers & Co. threatened to pull out of the $25 billion deal to buy its holding company SLM Corp (SLM) on July 11. The move could be a maneuver to try to lower the price of the purchase, which was set at $60 per share when it was announced. It might also reflect recent rumblings in the high-yield debt market and scrutiny into how private equity firms are financing their deals.

Sallie's stock closed at $52.15 on July 11, down 9.78% on the news.

At issue for the Flowers-led group: The government subsidies that the company receives to help keep down interest rates on the loans it makes. When the buyout deal was announced, legislators had been pushing to decrease the amount that the federal government subsidizes student loan providers by $15 billion. Since then, members of the Senate have advocated to boost that number to $20 billion. Sallie's prospective buyers said this would cut into the margins on its federal student loan business, which stand at around half of one percent. State attorneys general and lawmakers have also increased their scrutiny of the student loan business over the past several months. The private buyers told Sallie Mae today that these developments "could result in a failure of the conditions to the closing of the merger to be satisfied."

But most of the proposed legislation had been discussed before the deal was announced. The actual effects of a reduction in subsidies over what had already been expected when the deal was announced in April could be miniscule, said Jason Brady, a portfolio manager at Thornburg Investment Management.

"We're talking about single digit percentage changes in earnings," Brady said. "When they announced this deal, the legislation was already out there."

It is more likely that the private equity buyers are using the legislative proposals to whittle away at the price they will have to pay shareholders to buy the company.

"This is probably something that could take 10% off of the price," S&P equity analyst Stuart Plesser told (S&P, like, is a unit of the McGraw-Hill Companies [MHP]).

The private buyers may also be reacting to the increased cost of financing the deal as interest rates rise. Moreover, investors are becoming weary of buying up the large amounts of debt issued as a result of the private equity boom (see, July 10, 2007, "End of the Private Equity Party?"). Sallie would be taking on $16.4 billion in debt to pay for the acquisition and even though no deal has yet gone through, the company's bonds have traded significantly lower since the announcement (see, June 19, 2007, "A Savvy Bet on Sallie's Debt?").

When announced in April, the deal was groundbreaking in that it was the first leveraged buyout of a major financial company. The buyout was backed up by $200 billion in financing from JP Morgan (JPM) and Bank of America (BAC).

SLM Corp said in a statement that it is moving as quickly as possible to try to close the deal. Before today, analysts had predicted that the deal might close around August. But the push-back from the suddenly nervous investor group may mean Sallie won't be a Summer bride – or could be left at the altar altogether.

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