Bye-bye, Private Equity Premiums

The falling shares of Macy's and other potential takeover targets suggest that this era of lofty buyouts is likely over

On a disastrous day for stocks, the 5.3% decline in shares of Macy's (M) was particularly noteworthy.

Just eight days earlier, Macy's soared above $43 on a media report that private equity group Kohlberg Kravis Roberts was exploring a bid for the retailer.

The Cincinnati- and New York-based retailer had gained steadily since June, as analysts viewed its brands, real estate portfolio, and cash flow as tempting for private equity players, who would offer a significant premium in an acquisition. So much for that idea: Macy's is now at $38. On Wall Street these days, the credit-market meltdown has effectively taken juicy buyout premiums off the table.

And the Macy's takeover premium isn't likely to come back any time soon. The company's shares bounced around a bit last year, even breaking into the mid-40s amid hopes of a buyout. But that was in the midst of a roaring buyout boom (see, 7/19/07, "Is the End of the M&A Boom at Hand?").

Boom Meets Credit Crunch

That boom has struck a major obstacle, as credit investors balk at buying the loans used to fund already-announced deals such as Cerberus Capital Management's bid for the U.S. Chrysler Group division of DaimlerChrysler (DCX). On July 26, Tyco International (TYC) was forced to cancel plans for a $1.5 billion debt offering because credit conditions were too tight.

"The party is probably over for private equity. There will still be private equity deals, but fewer of them and the quality of the deals should improve," economist Edward Yardeni, president and chief investment strategist of Yardeni Research, said in an note to investors. "There will still be plenty of M&A deals, but more of them will be based on business strategy, rather than financial engineering." Yardeni projects that private equity's share of M&A activity could be cut in half during the remainder of 2007.

Macy's investors are hardly alone. Lots of stocks rose in recent months as the expectation of a lofty buyout fueled the bulls. Now that the buyout boom has peaked, the shares of potential takeout targets are settling back to earth as well. Fast-food chain Wendy's International (WEN) fell 4.9% on July 26, to $33.41, down from a May high of $40 when speculation over a possible buyout reached a peak. Wendy's said earlier in the year that it would consider a sale or other measures to boost shareholder value. But the effort led nowhere as analysts questioned whether the stock was priced too high for a deal.

In a related phenomenon, Tim Backshall, chief strategist at Credit Derivatives Research, noted that shares of online travel site Expedia (EXPE) have declined as the odds of it completing a dividend recap have been reduced. Shares of Expedia traded at $26.37 on July 26, down from $29 in early June. Expedia said July 23 that it was canceling 80% of a planned stock buyback, reducing it to 25 million shares from 116.7 million shares. The company said it had not been able to secure financing with attractive terms to make the buyback work.

Record-Breaking Days of Yore

Just a few months ago, printer R.H. Donnelley (RHD) was subjected to rival takeover bids. A group led by private equity shop Madison Dearborn Partners bid $7.3 billion for Donnelley, and a group led by The Blackstone Group (BX) made a rival bid, according to press reports. Donnelley never accepted either deal. On July 26, Donnelley shares fell $6.41, or 8.7%, to $66.67. Part of the decline reflected an acquisition of Web site, and fears that the Yellow Pages publisher would face steep competition from the Web. But the shares have been falling since topping $84 in early May, just a few weeks after takeover speculation reached its peak.

The private equity boom set one record after another during the last few years. The volume of global mergers and acquisitions was a record $4.06 trillion in 2006, up 36% from $2.99 trillion in 2005. The record pace was maintained during the first half of 2007, with $2.88 trillion in announced deals. It culminated with the record $48.5 billion buyout of Canadian telecom company BCE (BCE) by Madison Dearborn, Providence Equity Partners, and the Ontario Teachers' Pension Plan, which is pending. Much of that boom was driven by the huge runup in the number of leveraged buyouts, which accounted for a record 18% of M&A in 2006, up from 12% in 2005.

The boom in deals drove the stock market higher as well. The Dow Jones industrial average finally broke through the 14,000 mark on July 19—with much of the advance reflecting beliefs that private equity companies would step forward with rich premiums in go-private deals (see, 3/28/07, "Prospecting for Private Equity Targets"). But as credit tightens, buyout financing terms will become stricter, and those expectations on premiums will fade. And, in the end, investors are likely to lose their penchant for betting on big takeovers.

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