Backing Off From Buyouts

The U.S. merger-and-acquisition boom may have slowed, but the market's fundamentals remain strong.

The chill that swept across the global credit markets this summer forced a bunch of leveraged buyout deals onto the back burner. At the end of July, for example, General Motors postponed a $3.1 billion debt sale to finance the buyout of its Allison Transmission unit, and Chrysler Group delayed a $12 billion loan deal to fund its buyout from DaimlerChrysler AG by Cerberus Capital Management.

"One simply has to take the view at this point that the market for large-scale leveraged loans to fund M&A and dividend re-cap activity has peaked, at least for the intermediate term," asserts Richard Grice, co-leader of Alston & Bird's global finance and debt products group.

So, is the five-year buyout boom in the U.S. running out of steam?

It's not just highly leveraged deals that are threatened by tightening credit. "The lenders who are providing capital for private equity and M&As don't want to be stuck with the collateral -- a company that has minimal market valuation, unrealized EBITDA, and the like," reports Rosemarie Truman, director of PRTM Management Consultants' financial services group. "They are becoming much more cautious about the deals they invest in, since they will need to get payback from IPOs, accelerated growth, and/or operational synergies [for which monetization is questionable]."

"It appears that the cost of credit is going to be rising," adds Tim Mahon, a principal at consulting firm Anderson Economic Group. But a more critical factor is access to credit, he says. "As we saw between 2000 and 2002, it was not the cost of credit that limited the markets, it was the ability to get credit as the application criteria and covenants became much more restrictive."

Covenant-"lite" deals may well become a thing of the past, according to Grice. With the return of financial covenants, "buyers will once again be forced to really sharpen their pencils and determine whether the acquisition in question will perform sufficiently well to meet those financial ratio targets, or face default."

But while the parallels with the early years of the decade are clearly there, few market observers expect to see a serious contraction in the deal pipeline. Truman notes that while current multiples are high, "they are being matched, albeit at a slower rate. So M&As will slow, not stop."

Troy Prewitt, a vice president at BKD Corporate Finance in Kansas City, notes that at the end of the '90s buyout binge, multiples fell substantially. But he doesn't see that happening now. "We expect multiples to remain at or above historical averages for the foreseeable future," he reports. "During the late '90s, unprecedented equity capital flowed into the dot-com gold rush. I personally witnessed hundreds of millions of dollars deployed without sufficient preliminary due diligence. Money was wasted instead of being put to productive use, and September 11 exaggerated the decline of that market. Today, risky capital is being put to prudent use, corporate balance sheets are stronger than in the late '90s, and, barring any unexpected external calamity, we should see a much softer landing."

Further down the line, the market may well bounce back as corporate buyers, armed with cash and equity, seek out new opportunities. Says Mahon: "Once again, cries of pecuniam regnum! -- cash is king! -- will ring out. Those with the ability to fund and not require much leverage will be able to short-circuit the process and offer a stronger, more substantial bid." And at that point, the boom could be back with a vengeance.