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LBOs See Rise in Debt Ratios

As investors in junk bonds become more cautious, some deal sponsors turn to the leveraged-loan market.
Stephen Taub, CFO.com | US
April 12, 2005

Debt is becoming a larger component of the capital structure of leveraged buyouts, according to The Wall Street Journal, but some sponsors are having trouble raising the money to complete the deals, thanks to rising interest rates and growing concerns for credit quality.

This year's first quarter saw $31 billion in LBO deals, according to the Journal, citing Standard & Poor's. On average, equity accounted for less than 30 percent of the deals' total value for the first time since 2000, the paper noted. Meanwhile, debt exceeded earnings before interest, taxes, depreciation, and amortization by 5.2 times, the widest ratio since 1998, when deals were booming.

In fact, loans for leveraged buyouts reached $16.24 billion in the first quarter, the most in at least seven years, according to Bloomberg, which also cited S&P.

In the first quarter, the average time between the initial LBO and a dividend payout for the sponsors dropped to 11 months, added the Journal, which observed that the dividends increase the debt loads even more.

Large, leveraged deals are no longer a slam dunk, however.

Fiberboard maker Masonite International Corp., which is being bought by Kohlberg Kravis Roberts, recently junked its $825 million high-yield offering when it couldn't attract enough investors at the interest rate the sponsors were seeking, according to several reports.

And last week NewPage Corp., a paper company being bought by Cerberus, slashed its planned sale of junk bonds by $500 million, to $900 million, according to Bloomberg.

"The market has essentially shut down for the type of low-quality borrower that we saw prior to March,'' Mark Hudoff, a portfolio manager at bond powerhouse Pacific Investment Management Co., told the wire service. "The hurdle has gotten a lot higher" for high-yield borrowers.

Investors in junk bonds have become more cautious of late, partly due to fears that General Motors may be downgraded to below-investment-grade status. Bloomberg also pointed out that last week, yield spreads on junk bonds swelled to 3.59 percentage points, up from the low this year of 2.71 percentage points just a month ago.

Some deal sponsors are turning to the leveraged-loan market, which is still experiencing strong demand from risk-taking investors like hedge funds. "Total capacity in that market has gotten very large," Rob Hedlund, head of high-yield bond and leveraged-loan syndication at Lehman Brothers, told the Journal. Leveraged loans typically come with floating rates, which can be very attractive for investors in a rising-rate market.

"Business has remained strong in leveraged loans," Donald Pollard, global co-head of syndicated loans at Credit Suisse First Boston, told Bloomberg. "We see a steady supply of deals and the market continues to absorb new offerings."




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