LBO Financing faces increasing challenge

Chrysler, Boots Financing Woes Dim `Golden Era' for Buyouts
By Edward Evans and Jason Kelly

July 26 (Bloomberg) -- The ``golden era'' for leveraged buyouts proclaimed by Henry Kravis two months ago is losing its luster.
Kravis, co-founder of New York-based Kohlberg Kravis Roberts & Co., said on May 29 that there was ``plenty of capital'' to finance acquisitions. Yesterday, Chrysler and Alliance Boots Plc failed to find buyers for $20 billion of loans to pay for their buyouts. Ten banks, including Deutsche Bank AG and JPMorgan Chase & Co., were stuck holding the debt.

LBO firms, which announced an unprecedented $690.4 billion of takeovers this year, need to raise $300 billion of debt to fund purchases, according to data compiled by Bear Stearns Cos. That's going to get harder because investors, hit by losses on subprime mortgages, are shunning riskier bonds and loans.

``You're going to see more broken deals,'' billionaire investor Wilbur Ross said in an interview yesterday in New York. ``If the investment banks continue to get hung up, their appetite for risk is going to go down. That'll be a big change.''

Sales still in negotiations are being affected. Cadbury Schweppes Plc, the London-based maker of Dairy Milk chocolate, may get less than the $15 billion sought for its U.S. beverage unit as two buyout groups bidding for the division struggle to arrange funding, people with knowledge of the talks said yesterday.

It may also mean lower fees for Wall Street firms. Deutsche Bank, Germany's biggest bank, JPMorgan, the third-largest in the U.S., Credit Suisse Group, Switzerland's second-biggest bank, and New York-based Goldman Sachs Group Inc., the world's most profitable investment bank, took the biggest share of the $8.4 billion in fees paid by LBO firms in the first half, according to data compiled by Freeman & Co. and Thomson Financial in New York.

`Ugly' Scenario
``You've got an ugly short-term scenario,'' said Marek Gumienny, managing director at London-based buyout firm Candover Investments Plc, in a telephone interview yesterday. ``There will be pressure from credit committees at banks to reprice, restructure and offload this stuff.''

KKR has announced $136 billion of leveraged buyouts this year. Buyers typically fund LBOs with debt backed by the target's assets. They pay off the borrowing using cash flow and profit by selling the company three to five years later.

Kravis, who helped create the LBO business in 1976 with his cousin George Roberts, needs to raise money to pay for credit- card-payment processor First Data Corp. of Greenwood Village, Colorado, and Harman International Industries Inc., the Washington-based maker of Harman Kardon speakers.

Gross, Dimon
Since Kravis, 63, made his ``golden era'' comment in a speech to Canada's Venture Capital & Private Equity Association, almost 40 bond and loan sales have been canceled or restructured. Record defaults on U.S. subprime mortgages triggered the flight from below-investment-grade debt.

Bill Gross, chief investment officer at Pacific Investment Management Co. in Newport Beach, California, said on July 24 that lenders are ``frozen'' and ``absolutely nothing is moving.'' Jamie Dimon, chief executive officer of New York-based JPMorgan, described the drop in demand last week as ``a little freeze.''

Frankfurt-based Deutsche Bank, which is leading the financing for KKR's takeover of Nottingham, England-based pharmacy chain Alliance Boots, failed to sell 5 billion pounds ($10 billion) of senior loans to fund Europe's biggest LBO, two people with direct knowledge of the negotiations said yesterday. Chrysler, the U.S. unit of Stuttgart, Germany-based DaimlerChrysler AG, postponed the $10 billion sale of loans for its buyout by New York-based Cerberus Capital Management LLC, according to investors briefed on the decision.

Banks' Expense
``LBO financing has got much more expensive,'' said Willem Sels, a credit strategist at Dresdner Kleinwort Ltd. in London.

While terms of the Chrysler and Alliance Boots takeovers may have to change, both will still be completed. The banks funding the sales, rather than the buyout firms, have committed to covering most of the extra cost.

``Too many people have forgotten that underwriting is underwriting: you're on risk,'' Candover's Gumienny said. ``Some banks may not be in a position to do deals at the moment until they've reduced their credit or feel they can syndicate very easily. They're not going to be rushing out, throwing money at things.''

The private-equity firms aren't low on cash themselves. Pension funds, university endowments and wealthy individuals poured a record $210 billion into buyout funds last year, according to data compiled by London-based research firm Private Equity Intelligence Ltd.
`Huge Pipeline'

While mergers and acquisitions may slow, private-equity firms and their banks won't abandon LBOs unless the broader economy stumbles, said Warren Hellman, co-founder of San Francisco-based buyout firm Hellman & Friedman LLC.

``If there's a turn in the economy, a lot of stuff, the mega-stuff that's been done is going to start to look troubled,'' Hellman, a former president of New York-based Lehman Brothers Holdings Inc., said in an interview in San Francisco. ``That's the most concerning thing.''
The slide will be gradual, rather than an implosion that kills almost every LBO, said Mitchell Cohen, a managing director at Hellman & Friedman.
``It will be a little bit awkward for the next couple of months when this huge pipeline of stuff works its way through,'' Cohen said in an interview.