Mezzanine funds gain an edge in credit market turmoils

LBOs Find Cash as Goldman, TCW Raise Mezzanine Funds (Update1)

By Sree Vidya Bhaktavatsalam and Jason Kelly

Dec. 13 (Bloomberg) -- Goldman Sachs Group Inc., TCW Group Inc. and New York Life Capital Partners are raising more than $30 billion to increase their investments in leveraged buyouts.

At least 32 firms are starting mezzanine debt funds as investors shun bonds and loans used to finance LBOs out of concern that the collapse of prices for subprime-mortgage securities will spread. Mezzanine funds make loans to companies at higher rates than banks and buy their preferred stock. They earn returns from interest payments and the eventual sale of the equity interest.

``Today, virtually no one is willing to finance LBOs and it's created an opportunity for mezzanine providers,'' said John Morris, managing director at Boston-based HarbourVest Partners LLC, which oversees $24 billion of private-equity investments for institutions.

Goldman, the world's most profitable securities firm, is gathering $20 billion for the biggest mezzanine fund, said two people with knowledge of the matter. TCW, which manages more than $150 billion, is raising $4.5 billion to split between two funds, said the people, who declined to be identified because the companies haven't disclosed their plans.

Officials at New York-based Goldman and TCW in Los Angeles declined to comment.

New York Life Capital, the investment unit of New York Life Insurance Co., raised $800 million last month for its second mezzanine fund, $200 million more than originally sought. The fund will provide financing for acquisitions as large as $4 billion, said Thomas Haubenstricker, a senior managing principal at the firm.

Funding Backlog

``We have the opportunity in this market to work on deals that are larger than what would typically come to our market,'' Haubenstricker said.

With financing readily available, LBO firms announced a record $582.6 billion of deals in the first half of 2007, data compiled by Bloomberg show. That fell to $171 billion in the past five months as lenders were left with $370 billion of debt that they couldn't sell to investors, according to a Sept. 24 note by analysts at Bank of America Corp. in New York.

``When the big commercial banks move, they go far in both directions,'' said Rick Rickertsen, managing partner of Washington-based private-equity firm Pine Creek Partners.

While the banks have reduced some of the backlog, they are still sitting on $230 billion of debt, according to a Dec. 4 report by JPMorgan Chase & Co. analysts in New York.

Taking More Risk

Private-equity firms use funds raised from investors to finance as much as 30 percent of their acquisitions. They borrow the rest against the assets of the companies they buy, using the business's cash flow to pay down the debt.

As much as 50 percent of the funding comes from senior debt, which banks package and sell to investors. The remainder is financed using high-yield loans and mezzanine debt, which is unsecured, high-yield borrowing that ranks last for repayment in the event of default.

``The ability to access the high-yield markets, which is a very important component of all buyouts, has if not disappeared, become very tough,'' said Scott Sperling, co-president of buyout firm Thomas H. Lee Partners LP in Boston, said today in a Bloomberg TV interview. ``That makes mezzanine financing a more attractive alternative and sometimes the only alternative to help finance buyouts.''

Mezzanine funds also acquire equity in some buyouts to generate higher returns for investors. They take the added risk to earn annual returns of as much as 20 percent before fees, said Patrick Campbell, a principal at New York-based Benedetto Gartland & Co., which raises money for mezzanine-fund managers.

By contrast, junk bonds, often sold as part of LBOs, returned an average 6.97 percent from 1997 to 2006, according to indexes compiled by Merrill Lynch & Co.

``Investors have a much greater appetite for mezzanine funds because the risk-return rewards are so much better,'' Campbell said.

The following is a list of the 10 largest mezzanine funds being
raised:

Fund                            Target     Manager
GS Mezzanine Partners V         $20B       Goldman Sachs
TCW/Crescent Mezzanine Fund V   $2.5B      Trust Co. of the
West
TCW Energy Fund XIV             $2B        Trust Co. of the
West
N.Y. Life Mezz. Partners II     $800M*     N.Y. Life Capital
Capzanine II                    $368M**    Capzanine
CapitalSouth Partners Fund II   $300M      CapitalSouth
Partners
Darby Asia Mezzanine Fund II    $300M      Darby Overseas Ltd.
Darby Latin Am. Mezz. Fund II   $300M      Darby Overseas Ltd.
MidWest Mezzanine Fund IV       $200M      Midwest Mezzanine
BNY Mezzanine Partners          $200M      Bank of N.Y./Mellon

*Closed
**250 million euros

3i NAV advances

3i Net Asset Value Advances 27% Amid Credit Turmoil (Update5)

By Edward Evans

Nov. 8 (Bloomberg) -- 3i Group Plc, Europe's biggest publicly traded private equity firm, said the net value of its assets rose 27 percent in its fiscal first half even as rising borrowing costs crimped the pace of leveraged buyouts.

Net asset value rose to 1,007 pence a share in the six months to Sept. 30 from 792 pence in the year-earlier period, Chief Executive Officer Philip Yea said on a conference call with reporters today. That beat the 981 pence average forecast of three analysts surveyed by Bloomberg News.

Yea is boosting infrastructure and growth-capital investments to increase returns while allocating less to buyouts as banks struggle to clear, or syndicate, a backlog of leveraged loans. After a record $579 billion of takeovers in the first half, the pace of buyouts has slumped by almost 50 percent, according to data compiled by Bloomberg.

``In terms of summer's dislocation in the leveraged finance markets, the effect on mid-market hasn't been as pronounced as at the large end,'' Yea, 52, said today. ``We weren't as reliant on big underwritten syndications as the top of the market.''

3i reaped 1.04 billion pounds ($2.2 billion) from selling investments including Aibel Ltd., a Norwegian offshore oil and gas service provider, and Care Principals, a chain of British nursing homes it sold to a Qatari fund for 270 million pounds in July. That rate of realizations may now slow, the company said.

Less Debt

The firm spent 1.23 million pounds on new investments in the first half including stakes in Deutz Power Systems, Eltel and Bestinvest, a British investment adviser. That's more than double the 598 million pounds 3i spent in the same period last year. The firm spent more on so-called growth capital investments than buyouts.

The effect of rising U.S. subprime-mortgage defaults on consumer and business confidence is ``yet to be fully played out,'' Yea added. The firm is also using less debt to fund its buyouts.

``Some of the wonderful terms we saw in the first half of last year, like covenant-lite loans, toggles, they're gone,'' 3i's buyout chief Jonathan Russell told analysts on conference call. ``They were lovely at the time. We've returned to a state of reality.''

3i shares were unchanged at 1,016 pence in London, valuing the company at 3.9 billion pounds. The stock has dropped 17 percent since touching a high of 1,236 pence in May as buyouts slowed.

Analyst Ratings

Of the six analysts who rated 3i shares this year, five recommend investors ``buy'' the stock and one advises them to ``hold'' it, according to data compiled by Bloomberg.

3i raised 700 million pounds in a March initial public offering of a fund that targets infrastructure investments. By August, the fund had invested half that money in projects such as oil and chemical storage facilities. 3i is preparing to raise $1 billion for a fund for infrastructure in India.

Growth-capital investments are typically minority investments in companies worth up to 1 billion euros ($1.5 billion). 3i typically invests cash to fund takeovers or boost growth by expanding overseas.

Started after World War II by Prime Minister Clement Attlee to invest in small businesses, 3i looks for undervalued or out- of-favor companies or start-ups that promise rapid growth. The company raised a 5 billion-euro buyout fund last year.

Dated article on roll-ups

High Rollers
A new generation of financial hot-shots are making their fortunes on roll-ups -- risky consolidations of IPOs. The risks are even greater for the CFO in the middle.
Joseph McCafferty
CFO Magazine
April 01, 1998

The day before last Thanksgiving, then-39-year-old financial whiz Jonathan Ledecky pulled off a bold deal. He went to the public equity markets and raised half a billion dollars for his company, Consolidation Capital Corp., in an initial public offering. What made this deal so brazen was not just that Consolidation had yet to earn a dime. In fact it had no revenues, no assets, no operating history, and no identity. Ledecky hadn't even settled on an industry for his new venture. He raised the capital in a blind pool on the strength of his reputation alone.
That reputation rests on his ability to build so-called roll-ups. These are companies created to consolidate fragmented industries by gobbling up small mom-and-pop businesses. But unlike regular consolidations, in which strong industry leaders buy up weaker rivals, roll-ups are started from scratch.

Here's how it works: A promoter like Ledecky finds between 5 and 10 private companies in the same industry that agree to sell their businesses for cash and stock from the proceeds of an IPO that has yet to occur. The IPO and the merger of the founding companies occur simultaneously. Using its stock as currency, the new company continues the acquisition binge in the hope of eventually creating a national power-house that will dominate the industry.

Roll-ups are red hot on Wall Street. At last count, about 90 roll-ups had gone public since one of the first, U.S. Delivery Systems Inc., debuted in 1994, including 50 in 1997 alone. And the frenzy continues, with an average of 5 coming to market each week.
Also called "poof" companies because of the way they seem to materialize out of thin air, roll-ups are consolidating such industries as funeral homes, dry cleaners, flower wholesalers, bus lines, home builders, and air-conditioning repair services. In fact, roll-ups have popped up in every fragmented industry.

But the risks in these deals are as great as the rewards. "There are so many hurdles to overcome that it is very difficult to pull these deals off," says Patrick Sullivan, partner in charge of acquisition advisory services for Coopers & Lybrand LLP in Los Angeles.
That hasn't stopped Ledecky and those like him from trying. They are financial cowboys, '90s style. But unlike 1980s' corporate raiders T. Boone Pickens and Carl Icahn, who made a killing preying on conglomerates and selling off their pieces, these cowboys make money by putting the pieces together. In that sense, roll-ups are the reverse of the leveraged buyouts of the '80s. Sullivan calls them "leveraged buildups," because they leverage equity to build the company.

The king of consolidators is H. Wayne Huizenga, owner of the Florida Marlins baseball team. Huizenga pioneered the technique by rolling up garbage-truck businesses to create Waste Management Inc., the nation's largest waste company. He went on to create the largest video chain, Blockbuster Video, and is trying to work his magic on the auto retail industry through Republic Industries Inc.
Now promoters have taken the concept to the next level, with roll-up IPOs. Ledecky, who created one of the earliest and now largest roll-ups, U.S. Office Products Co. (USOP), has since created three more--USA Floral Products Inc., a flower distributor; Consolidation Capital; and UniCapital Corp., a consolidator of commercial leasing firms that filed to go public in February. These three were all done in the past year, while Huizenga took 25 years to get to his third.

The man with the most notches on his belt, though, is Steve Harter, chairman of Notre Capital Ventures II, a Houston-based investment bank. Harter has six bronze bulls, awarded by the New York Stock Exchange when a company is listed there, to prove it. He sharpened his skills doing M&A work for Arthur Andersen LLP and, later, analyzing acquisition candidates for Allwaste Inc., a Houston environmental-waste company. After orchestrating the U.S. Delivery roll-up, he completed five more, including some of the most successful yet. Coach USA Inc., a roll-up in the motor coach industry, went public in May 1996 at $14 a share and has more than doubled to a recent close of $38. Another of Harter's creations, Metals USA, is up 60 percent, to a recent high of $16 since its initial offering last July.

Harter also started Comfort Systems USA Inc., which is out to consolidate the air conditioning and heating industry; Physicians Resource Group Inc., a consolidator of ophthalmology practices; and his most recent IPO, Home USA Inc., a consolidator of mobile-home retailers that went public last November.

FEES THAT MATCH THE P/EsClearly, the success stories are alluring. But roll-ups have their critics. Among them, oddly enough, are the stronger players, who take aim at less-scrupulous copycats. "There is a tremendous amount of financial alchemy going on," says Harter. What concerns them is that roll-ups can be a house of cards. After the IPO, the roll-up continues to acquire companies, using equity it raised at high P/E ratios to buy smaller private companies that trade at lower multiples. This arbitrage helps maintain the roll-up's high ratio and the acquisition binge; it's a machine that feeds itself.

But P/Es are as much about investors' perceptions as about earnings. If investors come to doubt that earnings can be sustained, the multiple will come down, throwing sand into the gears. And it's virtually a foregone conclusion that every industry will ultimately run out of suitable acquisition candidates. Yet consolidators almost always cite the arbitrage as the key to their strategy. "It is the concept," says Ledecky. "It's a gerbil wheel." At that point, investors in roll-ups will have to worry whether their company can effectively manage what it owns.

Trouble is, roll-ups often lack experienced management teams. "Roll-ups tend to be headed by executives who have experience in roll-ups, but not in the industry," says Samuel Hayes, a finance professor at Harvard Business School. That, he says, can be a recipe for disaster. Indeed, some observers contend that once traditional measures of performance are applied, like comparison of same-store sales or other measures of operational growth, lofty P/E ratios will fall back to earth even before a roll-up runs out of potential targets.

"Fueling growth by buying companies with lower P/E ratios has long been discredited as a strategy that has no rationale," says Geoffrey Brooks, an assistant professor at the University of Pennsylvania's Wharton School. He cites the failure of diversification in the 1960s as a prime example. Jeffrey Evans, vice president of research at Credit Lyonnais Securities (U.S.A.) Inc., agrees. "It's the greater-fool theory. At some point it has to stop, and someone is left holding the bag." Often that includes the CFO.

Consider Fine Host Corp. The Greenwich, Connecticut-based food-service firm set out to consolidate small players that run concessions and cafeterias at universities, corporations, and sports arenas. It went public in the summer of 1996 at $12 a share and shot up to $43 by the fall, buoyed by a flurry of acquisitions. But in April 1997, the CFO, Nelson A. Barber, was suddenly demoted to treasurer, and by October analysts were complaining about a lack of information. In December, the stock fell 64 percent when the company removed Barber and its CEO, Richard E. Kerley. The company later admitted it had recognized some income before it was earned and incorrectly capitalized certain expenses, and restated earnings back to 1994, incurring losses instead of profits. The Securities and Exchange Commission is conducting an informal investigation.

In many cases, though, the promoters and underwriters make a killing whether the roll-ups bear fruit or not. "The people who financially engineer these deals make an enormous amount of money," says Patrick Hurley, partner and M&A director at Howard, Lawson & Co., a Philadelphia investment bank. He says that the promoters get a large equity stake for a very small up-front investment. "If they have been able to sell stock, they've made money whether the roll-up succeeded or not." (Often they are locked into agreements that prevent them from selling for 12 to 18 months.) Up-front fees for underwriting, accounting, and legal services are also high due to the complexity of the deals. Hurley estimates that total managers' fees related to completed roll-ups, including the management fee, underwriting fee, and selling concession, are about 50 percent higher than for normal IPOs.

When roll-ups do go wrong, the underlying problem is most often a focus on the financial engineering at the expense of improving operating efficiencies. "The biggest risk in this whole phenomenon is that acquirers lose sight of the nuts and bolts," says Evans. "They just buy things to buy them." Perhaps this point is best illustrated by the title of the keynote presentation, "It's Easier to Buy 'Em Than to Run 'Em," at the upcoming second annual Industry Roll-Ups Conference, a how-to course on the strategy.

CONFLICT-RIDDEN?Some roll-up cowboys seem to have problems handling the conflicts of interest that can arise. Consider Ledecky. One of the companies he merged into USOP as it went public was Sharp Pencil, of which he himself was majority owner. Although he used $17.6 million of the February 1995 IPO proceeds to, in effect, buy himself out, Ledecky did not think it necessary to get an independent appraisal of Sharp's value, according to USOP's prospectus. Ledecky, who denies any conflict of interest, says he got the same multiple for Sharp Pencil as the other founding companies. "They were all valued in the same way. Everyone negotiated the deal together." Still, investors had little way of knowing whether the price was fair, because none of the financial information about Sharp in USOP's prospectus was audited, according to the filing.

Ledecky's conflicts of interest didn't end once he paid himself for Sharp. He took Consolidation Capital public even while serving as chairman of USOP and USA Floral. That raised the risk that he would make acquisitions for Consoli-dation Capital that might have as easily served USOP's and USA Floral's interests. "[Management] may have conflicts of interest in determining to which entity a particular business opportunity should be presented," says Consolidation Capi-tal's prospectus. And even if USOP, USA Floral, and Consolidation Capital weren't competing for the same businesses, Ledecky's time and attention could not be fully devoted to the interests of either or any of the companies, a factor that was also noted in the prospectus. Ledecky announced his resignation as chairman of USOP in January, effective this month.

MRI UNDER SIEGELedecky isn't the only roll-up artist to have engaged in questionable self-dealing. Gary Siegler, chairman of Medical Resources Inc. (MRI), a consolidator of medical imaging centers that went public in 1993, is also accused of indiscretions. The company is facing lawsuits related to questionable payments it made to 712 Advisory Services, a company Siegler controlled. Former managers allege that the advisory firm didn't earn the $1.5 million it was paid in cash and securities to advise on a number of MRI's acquisitions in 1997. Also, the ex-managers contend that Siegler arranged for MRI to take a $3 million stake in a private plane, which they claim was unnecessary. They allege that Siegler, who earned his wings working for Carl Icahn in the 1980s, wanted the plane for private use.

In early November, CFO John O'Malley was fired, and two other executives, chief operating officer William Farrell and general counsel Gary Fields, resigned after they raised the matter with the board and called for Siegler's ouster. They have since filed whistle-blower lawsuits. The company disclosed the departure of its CFO in a press release that also warned of earnings shortfalls, causing the stock to tumble to 83/4 from a high of 205/8 just a month earlier.

The company has launched an internal investigation, and is also being investigated by the New Jersey Attorney General's office, according to company filings.

WHY STOP AT OFFICE SUPPLIES?If Ledecky and Harter are the two founding fathers of roll-ups, their strategies couldn't be more different. Ledecky is a hands-on manager, often taking the position of chairman, while Harter builds the roll-ups and lets others with more experience in the industry run them. Harter likes to move slowly, focusing on integration of the acquired companies; Ledecky moves fast to build up a big organization as quickly as possible. Perhaps nowhere is that more evident than at USOP.

Sharp Pencil was one of six privately owned office-supply companies that Ledecky put together. But he didn't stop there. Two years and 220 acquisitions later, USOP was a member of the Fortune 500, with $3.8 billion in revenues. The stock had gone from $7.50 at the offering to a high of $27 in the summer of 1996. "It was crazy," says Donald Platt, senior vice president and CFO of the Washington, D.C., company. Of course, Platt relied heavily on outside resources, including a team of lawyers and accountants, to get the deals done.

Within these 220 acquisitions, are there no bad apples? "Not yet," says Platt. "We restricted them to well-managed, profitable companies. At worst, we would still be making money."

The trouble was, after grabbing that many companies, USOP had a patchwork of firms in six different businesses, including office supplies, travel, coffee sales, printing, and even educational supplies. The idea was to focus on the customer and provide one-stop shopping for corporate purchasers, rather than a tight industry niche.

At the pace Ledecky was moving, however, it was nearly impossible to attain significant economies of scale. Little integration was accomplished. Once purchased, in fact, a company was pretty much left alone. Ledecky not only kept existing management teams intact; he insisted they remain, locking them in with long-term agreements. Even the names of the companies were unchanged. And in only a few cases were warehouses and other overhead shared. "If you start to consolidate too quickly, you make the wrong decisions," says Platt. And buying well-run businesses left little room for improvement. Any integration they did do failed to increase margins. As a percentage of revenues, gross profit actually decreased from 28.1 percent for the nine months ended January 25, 1997, to 27.9 percent for the nine months ended January 24, 1998.

Without improving efficiency, USOP needed to keep up the acquisition pace to continue growing and keep the P/E ratio high. "Stock value is important. If you don't trade at a healthy multiple, using your stock as currency has less value," says Platt. "It absolutely feeds on itself. Success breeds success."

Until something finally gives. Without enough acquisitions or internal growth to drive earnings, USOP started to stumble. The stock fell to $16 at the end of 1997 from a high of $27.

In January, the company conceded that it could no longer sustain the current strategy, and reversed course. It decided to spin off four of the units--travel services, printing, educational supplies, and technology--and focus on its core businesses of office supplies, furniture, and beverages. And the executive who replaced Ledecky at the helm, Thomas Morgan, plans to do exactly what his predecessor couldn't: integrate with the aim of increasing efficiency through economies of scale. Just to be safe, the company also tapped the debt market for an additional $800 million to help fund a $1 billion stock buyback.

HELP WANTEDHarter has taken a different approach. In contrast to Ledecky, he intensely scrutinizes each acquisition and integrates each purchase completely into the organization. And he focuses on industries that have much to gain from better management, increased purchasing power, and increased efficiency. "If the customer doesn't benefit at the end of the day, you haven't created value," says Harter.
But he, too, has stumbled on occasion. Take, for instance, Physicians Resource Group (PRG), which Harter established as a roll-up in June 1995 to consolidate ophthalmology practices nationwide. It quickly grew from 10 practices at the outset to 177 by the fall of 1997. But costs grew even more rapidly. In the third quarter of 1997, the company reported a loss of $18.4 million, even though revenues grew to more than $100 million from $60 million a year earlier. Harter refused to comment on PRG's problems, but Richard D'Amico, PRG's chief administrative officer, admitted to the Dallas Morning News, "We grew too fast." Last November the company, now the largest eye-care group of practices in the nation, announced it was holding off on any more acquisitions, closing 14 of its troubled practices.

It is a common occurrence in roll-ups, says George Koo, an analyst with Burnham Securities Inc., in New York. "They move too quickly, projections aren't conservative enough, and costs get out of control." That's created plenty of opportunities for acquisition-minded CFOs. "In a roll-up, each of the things a CFO focuses on--raising capital, making acquisitions, improving operations, and talking to Wall Street--is at a fever pitch all the time," says Mike Kirksey, senior vice president and CFO at Metals USA, a Houston-based consolidator of metals processing firms. Perhaps the consolidation trail wouldn't have been so rough for PRG if it had had a strong CFO. For the two and a half years the company has been public, there have been no less than three finance chiefs.

"The CFO is crucial to the success of a roll-up," adds Kirksey. "The complexity requires someone with the skill to do the deals, but also to make them work, operationally."

Harter turned to Kirksey, former vice president of strategic planning at Keystone International Inc., a publicly traded valves and controls manufacturer in Houston, when he wanted to consolidate the metals-processing industry. Along with CEO Arthur French, also from Keystone, they created Metals USA. In any roll-up he starts, Harter has used professionals from the industry to run the business, though he has sat on four of his six companies' boards. "My ego doesn't need to be called 'chairman,'" he says.

THE GOLDEN GOOSEHarter at least has learned from his mistakes. Has Ledecky? He claims so. "One of the things I learned from U.S. Office Products is to focus," he says. But he already may be forgetting that lesson. In January, just days after USOP announced it was reversing its consolidation strategy and instead spinning off four separate roll-ups, Ledecky announced his plans for Consolidation Capital. The company will provide a variety of services to retail and office-building owners, including pest control, landscaping, and equipment maintenance. In February, it announced plans to acquire seven electrical contractors for $138 million, half of which would come in Consolidation Capital stock. When the acquisition is completed, Consolidation will be the fourth-largest electrical contractor in the United States. In a time when focusing on a niche is the standard, that will be a hard sell on Wall Street.

Eventually, many roll-ups will go the way of the LBO. When the stock market turns down, they will have a harder time using equity for acquisitions no matter how profitable they are. The cowboys themselves fear that day will come even sooner, as their corporate cattle drives fall victim to their own success.

"I have seen guys try to put these things together with mass mailings and Internet sites," says Harter. Fair warning for CFOs tempted to saddle up.

Financing's New Language

Financing's New Language

(CFO Magazine) Dealmaking language is changing, signaling less freedom for issuers and more protection for investors and banks. Gone are dividend recaps, refinancing, covenant-light deals, second-lien loans, and payment-in-kind (PIK). Back in the lexicon are market clauses, covenants, earnouts, and sellers' notes.

The return of vigilance is evident in the commitment letters banks give buyers to finance acquisitions. During the buyout frenzy, private-equity buyers often committed to purchasing companies without financing contingencies (like buying a house without the assurance you will be approved for a mortgage). In turn, private-equity firms pressed banks for firm financing commitments. Banks issued commitment letters without strong escape clauses and, as a result, were stuck with billions in debt they were unable to unload. Banks are now inserting tighter terms, including market clauses, which give them an out if market conditions worsen.

Covenants, once a staple, were removed in the frenzy, hence covenant-light deals. Omitting these agreements, which protect investors, enabled issuers to sell debt without obligating them to meet performance benchmarks. Covenant-light deals are now gone and traditional covenants are back. Also gone are PIK clauses. These toggle-like features enabled issuers to pay investors in bonds instead of cash at their choosing.

Financial buyers will also have to do without dividend recaps, which allowed buyers to reap a windfall long before exiting an investment by loading companies with extra debt. (Think Hertz and the $1 billion in additional debt that Clayton, Dubilier & Rice Inc., Merrill Lynch, and The Carlyle Group paid themselves just six months after acquiring the company in September 2005.) Ditto for refinancing. With debt tighter, companies on the edge may not be able to refinance with new cheap debt and instead may have to be sold. Gone too is unsecured debt such as second-lien loans.

With banks retrenching, buyers and sellers in M&A deals can expect more negotiations about bridging financing gaps. Helping close such gaps are earnouts and sellers' notes. Earnouts are benchmarks a company has to meet after it is sold, while sellers' notes mean a seller agrees to hold part of the debt. For example, to complete the sale of its wholesale unit in August, Home Depot had to agree to finance $1 billion of the deal price.

KKR may start selling TXU loan

KKR, TPG Bankers May Start Selling TXU Loan Next Week (Update2)
By Pierre Paulden and Jason Kelly

Oct. 5 (Bloomberg) -- Bankers for Kohlberg Kravis Roberts & Co. and TPG Inc. may start selling loans to finance the $32 billion purchase of Texas utility TXU Corp. next week as demand for high-yield debt increases, people with direct knowledge of the deal said.

Citigroup Inc. and JPMorgan Chase & Co. will seek buyers for at least $5 billion of loans to help pay for the biggest U.S. leveraged buyout, according to three people, who asked not to be named because the terms haven't been set.

Banks are offering discounts of as much as 4 percent to sell some of the $300 billion of LBO financing they promised before losses on subprime mortgages shut down the market for high-yield, high-risk debt in July. Lenders syndicated $9.4 billion for New York-based KKR's purchase of First Data Corp. last week, in a sign that investor appetite is returning.

``The tone of the market has been much better in recent weeks,'' said Clark Orsky, an analyst at high-yield debt research firm KDP Investment Advisors in Montpelier, Vermont. ``How much of the loans the banks can move off their books depends on how large a discount they are willing to take.''

KKR and Fort Worth, Texas-based TPG, formerly known as Texas Pacific Group, agreed to buy TXU in February. The firms and New York-based JPMorgan and Citigroup declined to comment. Dallas- based TXU is the largest power provider in Texas.

Sales of U.S. leveraged loans dropped to $12 billion in September from more than $50 billion in June, according to data compiled by Bloomberg. Demand picked up after the Federal Reserve lowered its benchmark interest rate by a half-percentage point Sept. 18.

Unsold Debt
TXU rose 10 cents to $68.90 in New York Stock Exchange composite trading. KKR is offering $69.25 a share.

KKR's banks may keep some of the debt on their balance sheets. TXU said in a July regulatory filing that the lenders would provide about $26 billion of loans and $11.3 billion in bonds. More than $3 billion of loans and $9 billion of bonds financing the purchase of Greenwood Village, Colorado-based First Data have yet to be sold.

The loans will comprise a $2.7 billion revolving credit line, a $1.25 billion letter of credit facility, a $16.5 billion term loan and a $4.1 billion delayed draw term loan, according to a filing today with the Securities and Exchange Commission. Banks also agreed to provide $11.3 billion of senior unsecured bridge loans until the bonds are sold. Oncor Electric Delivery Company, a subsidiary of TXU, will also receive a $2 billion revolving credit line.

In a revolving credit facility, money can be borrowed again once it's repaid; in a term loan, it can't.

Discounted Loans
The sale is scheduled to close Oct. 10, TXU said in the filing.

The banks on the TXU deal probably will sell the loans at a discount to attract investors, the people said. First Data's banks offered the loans at as much as 4 percent below face value.

Credit Suisse Group in Zurich and New York-based Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Morgan Stanley also committed to provide financing and are helping arrange the TXU loans.

The LCDX index, a gauge of confidence in the U.S. leveraged loan market, has gained 8.2 percent to 97.39 since July 30, according to Goldman Sachs, the largest securities firm.

Allison Transmission, the automobile-parts supplier formerly owned by General Motors Corp., started a $550 million sale of high-yield notes yesterday after delaying the offering in July, according to a person familiar with the offering. Indianapolis- based Allison is selling debt to help pay for its $5.6 billion leveraged buyout by Washington-based Carlyle Group and Toronto- based Onex Corp., Canada's biggest buyout firm.

Bankers for Carlyle and Onex completed a $1.5 billion sale of loans last month after offering the debt at a price of as low as 96 cents on the dollar.

Return of the LBO

Blackstone Rises as LBOs Show Signs of a Comeback (Update2)
By Jason Kelly

Oct. 5 (Bloomberg) -- Blackstone Group LP's shares climbed at almost five times the pace of the Standard & Poor's 500 Index in the past month on signs leveraged buyout firms will resume making acquisitions.

Blackstone, the New York-based manager of the world's largest buyout fund, has gained 35 percent since falling to a record low of $21.54 on Sept. 7. Fortress Investment Group LLC, which bottomed out on the same day, has advanced 40 percent.

Both companies have outpaced the 7.3 percent increase by the S&P 500 as investors return to buy leveraged loans and bonds needed to fund a record $739 billion in private-equity deals announced this year. After a two-month lull caused by a global sell-off of subprime mortgage bonds, companies including First Data Corp. and Allison Transmission have sold LBO debt, chipping away at a backlog of $300 billion in financing committed by investment banks, according to Bank of America Corp.

``There's an expectation of normalcy back in the market,'' said Geoff Bobroff, an independent investment consultant in East Greenwich, Rhode Island. ``They've raised a fair amount of money in the past year and it's burning a hole in their pocket.''

Blackstone rose $1.50, or 5.4 percent, to $29.08 at 4:17 p.m. in New York Stock Exchange composite trading. The company, run by Stephen Schwarzman, went public at $31 a share in June.

Fortress rose 32 cents, or 1.4 percent, to $23.55. The New York-based manager of hedge funds and private equity went public in February at $18.50.

TXU Loans
Bankers for TXU Corp., the Dallas-based power producer that agreed to a buyout by Kohlberg Kravis Roberts & Co. and TPG Inc., may begin selling at least $5 billion in loans to fund that deal, according to people familiar with the process.

KKR, based in New York, filed for its own public offering July 3. The firm, founded by Henry Kravis and George Roberts, is seeking to raise about $1.25 billion in an IPO.

Blackstone in August raised a $21.7 billion fund, its fifth and the industry's largest. Acquisitions this year by the firm, founded in 1985, included Hilton Hotels Corp. and Alliance Data Systems Corp.

Six of the seven analysts who rate Blackstone shares suggest buying the stock. One, Douglas Sipkin of Wachovia Securities, rates Blackstone ``market perform,'' the equivalent of a hold recommendation.

KKR says financing costs increased significantly

KKR Says Financing Costs `Increased Significantly' (Update3)
By Elizabeth Hester and Jason Kelly

Aug. 13 (Bloomberg) -- Kohlberg Kravis Roberts & Co., the private-equity firm that plans to raise $1.25 billion in an initial public offering, said the recent jump in borrowing costs for leveraged buyouts may hurt its funds' performance.

The cost to issue high-risk, high-yield debt has ``recently increased significantly'' and the New York-based firm may need to rely on investment banks to fund transactions, KKR said in a filing with the U.S. Securities and Exchange Commission today. Blackstone Group LP, manager of the world's largest private-equity fund, also cited ``more challenging financing'' when it announced earnings today.
``More costly and restrictive financing may adversely impact the returns of our leveraged-buyout transactions and, therefore, adversely affect our results of operations and financial condition,'' KKR said in its filing.

Investors, wary of risk after the collapse of the subprime-mortgage market, are shunning bonds and loans used to pay for buyouts including KKR's planned takeover of U.K. pharmacy chain Alliance Boots Plc. The extra yield investors demand to own non-investment-grade corporate bonds rather than Treasuries has climbed to 412 basis points from a record-low 241 on June 5, Merrill Lynch & Co. data show. A basis point is one one-hundredth of one percent.

About $330 billion in bonds and loans for announced deals remain unsold, according to an Aug. 8 estimate from Citigroup Inc. analyst Prashant Bhatia.

`Way Too Optimistic'
Private-equity executives and investment bankers are debating how long it will take lenders to sell that debt. Blackstone President Tony James said today that it's unlikely to happen in the near term.

``The sense that people will come back right after Labor Day is way too optimistic,'' James said on a conference call with investors. ``It will take a while to work through these issues.''

Blackstone, based in New York, said today that second- quarter profit more than tripled from a year ago to $774 million and revenue increased to $975 million from $325 million. The earnings report was Blackstone's first since its initial public offering in June.

While the early part of the period was ``fundamentally positive,'' concern over the U.S. housing market and the volume of debt waiting to be financed for LBOs created ``more challenging financing conditions'' that persist, Blackstone said in the statement.

Blackstone's Stock
Blackstone shares gained 1.7 percent to $25.71 in New York Stock Exchange composite trading. Earlier today, they rose as much as 7.8 percent, the most since the company's IPO.

KKR, founded by Henry Kravis and George Roberts, filed July 3 to sell shares of their management company to the public for the first time. Kravis and Roberts won't sell shares, and will use the money raised in the IPO to expand the firm and finance buyouts, the company said. The number of shares and the price weren't disclosed.

Net income for the quarter ended March 31 rose 46 percent to $380.9 million from $260.6 million in the year-earlier period, according to the filing. The company estimated that its buyout funds had $20 billion of investments as of March 31.

KKR paid current owners $318.8 million for the quarter ended March 31 and $1.06 billion in 2006. Before the IPO, the firm plans to make at least one cash distribution to owners of ``substantially all of the cash-on-hand,'' the filing said.

Antitrust Inquiry
KKR also disclosed in the filing that the U.S. Justice Department requested ``certain documents'' from KKR as part of an investigation into whether private-equity firms violated U.S. antitrust laws.

The Justice Department began an informal antitrust inquiry last year into the collaboration among buyout firms in some deals, a person familiar with the matter said last October.

Prosecutors haven't filed charges related to the probe.

Morgan Stanley and Citigroup are managing the KKR offering.

Flight to safety - Stocks rout may lead to renegotiation on LBO deals

Stock Rout May Prompt Leveraged-Buyout Renegotiations (Update3)
By Jason Kelly and Ambereen Choudhury

Aug. 10 (Bloomberg) -- The global stock-market decline dented shares of buyout targets including TXU Corp., SLM Corp. and First Data Corp., prompting speculation some deals may go back to the negotiating table.

Private-equity firms that said they would pay high premiums based on cheap debt and guaranteed financing are revising terms. Home Depot Inc., the Atlanta-based home-improvement retailer, said yesterday it may lower the price for the supply unit it agreed to sell in June to a group of buyout firms.

``As the markets get tighter, the companies have to reassess what's the give and what's the get,'' said Paul Schaye, managing partner of New York-based Chestnut Hill Partners, which helps buyout funds find deals. ``Everybody's going to see a little bit of pushback.''

Transactions are stumbling as investors reel from losses in the credit markets related to subprime mortgages. Bond declines have spread to equities, sending the Dow Jones Industrial Average of the largest U.S. stocks down 2.8 percent yesterday, its biggest drop since February. The Dow fell 31.1 points, or 0.23 percent today, after dropping as much as 1.6 percent during the session. In the U.K., the benchmark FTSE 100 Index fell 232.9, or 3.7 percent, to a five-month low of 6,038.3.

``Investors should expect markets to remain volatile over the next few months as events unfold,'' said Edward Bonham Carter, chief executive officer of Jupiter Asset Management Ltd. in London, which oversees about $40 billion in equities.

Deals Slow
Corporate and private-equity buyers have announced a record $3.17 trillion in transactions so far this year, driven in part by $712.6 billion in leveraged buyouts, according to data compiled by Bloomberg. Global mergers and acquisitions may fall this year, according to research by KPMG International.

As investors reject bonds and loans slated to pay for those buyouts, dealmaking is slowing. Companies including London-based Cadbury Schweppes Plc, the world's biggest candy maker, have delayed asset sales. Virgin Media Inc., the U.K.'s second-largest pay-television operator, delayed a sale of the company on Aug. 7 after the stock fell 19 percent in a month.

``We're definitely in a sentiment-driven marketplace and it's the opposite of the sentiment of February and March,'' said Robert Profusek, chairman of mergers and acquisitions at Jones Day in New York. ``I don't think the big deals are in jeopardy. It's just changing the dynamic.''

Ontario Teachers' Pension plan said in a statement today it will stand by the terms of its C$51.7 billion ($49.1 billion) agreement to purchase BCE Inc., Canada's biggest phone company, after the shares fell as much as 4 percent on speculation the deal would falter.
Teachers' and private-equity firms including Providence Equity Partners Inc. said June 30 they would buy the company for C$42.75 a share. The stock dropped 25 cents to $C38.85 today in Toronto.

Shares Fall
Shares of TXU, the top supplier of power in Texas, rose 10 cents today to $63.65 after dropping as much as 3.1 percent, bringing the decline to 5.4 percent since the end of May. Kohlberg Kravis Roberts & Co. and TPG Inc. agreed to buy the Dallas-based company for $69.25 a share. The stock has dropped 6.6 percent in the past month.

SLM Corp., the student-loan provider known as Sallie Mae, fell 95 cents, or 1.9 percent, after declining as much as 4.2 percent. The shares have declined 17 percent from their 2007 peak a month ago. Buyout firms led by J.C. Flowers & Co. of New York agreed in April to buy Reston, Virginia-based SLM for $60 a share.

First Data, which agreed to be taken private by New York- based KKR in April, rose 4 cents to $31.05 after dropping as much as 6.1 percent. The stock has decreased 5.1 percent since July 10. KKR agreed to pay $34 a share.

Representatives of TXU, KKR and J.C. Flowers declined to comment. First Data spokesman Colin Wheeler said the company didn't comment on its stock price and ``remained confident the transaction will close in the third quarter.''

Sallie Mae expects its deal to close in October and the transaction isn't contingent on financing, spokeswoman Martha Holler said.

Hot money abandons credit markets, Loans find few buyers

LBO `Freeze' Shuts Wall Street Pipeline; $1.3 Billion Dries Up
By Edward Evans and Jason Kelly

Aug. 6 (Bloomberg) -- While investment bankers feasted on an unprecedented $8.4 billion of fees for arranging leveraged buyouts in the first half, the rest of the year may prove to be a famine.

``It's impossible to conclude that it's not going to be a tougher time for Wall Street,'' said Steven Rattner, co-founder of New York-based buyout firm Quadrangle Group and former vice chairman of Lazard Freres & Co. ``There's going to be an impact on revenues and profits.''
While no one's predicting a Biblical seven-year drought, the pace of buyouts has slowed more than 33 percent since June, data compiled by Bloomberg show. Investors are cutting back on riskier assets such as the loans and bonds that fund LBOs after being burned by losses from U.S. subprime mortgages. At that rate, banks would miss out on at least $1.3 billion of fees in the second half.

JPMorgan Chase & Co., the third-biggest U.S. bank, has the most at stake after earning more than anyone else from arranging leveraged loans in the first half. Together with Credit Suisse Group and Deutsche Bank AG, it made a combined $919 million from loans in period, data compiled by New York-based Freeman & Co. and Thomson Financial show. The three also got $426 million for advising LBO firms on takeovers and $190 million from bond sales.

Mortgage defaults by Americans with poor credit histories prompted the collapse in June of two hedge funds managed by Bear Stearns Cos. and triggered a worldwide rout in the debt markets. Companies such as London-based Cadbury Schweppes Plc, the world's biggest candy maker, have delayed asset sales, and banks including New York-based JPMorgan and Frankfurt-based Deutsche Bank have been left on the hook for as much as $300 billion of debt they've agreed to provide for LBOs.

`Grinding Halt'
``There's indigestion, as investors aren't buying the paper to the extent that they were buying it before, and banks will be nervous about committing to any new significant underwritings of any size,'' said Daniel Stillit, a London-based analyst at UBS AG. ``There's a significant risk of the LBO driver coming to a grinding halt.''

A 50 percent drop in income from arranging buyouts and other ``higher-risk credit,'' together with a 10 percent decline in other investment-banking revenue would slash earnings at Zurich- based Credit Suisse by 19 percent, London-based Deutsche Bank analyst Matt Spick said in a July 26 note to investors. Credit Suisse spokeswoman Rebecca O'Neill declined to comment.

Private-equity firms announced a record $616 billion of buyouts in the first half, capping four lucrative years of deals, according to Bloomberg data. New York-based Morgan Stanley, the second-biggest U.S. securities firm, is set to earn $45 million from New York-based Kohlberg Kravis Roberts & Co. for the $25.6 billion buyout of First Data Corp., the world's largest processor of credit-card payments.

Chrysler Sale
The takeovers have depended on the banks finding investors to buy debt. LBO firms use borrowed money to fund about two thirds of the cost of the deals. Bankers typically earn fees of 2 percent for underwriting loan sales for buyouts.

``Private equity has been an engine of growth for us and the industry in general,'' said Gary Crittenden, chief financial officer of Citigroup Inc., the biggest U.S. bank, on a July 27 conference call with investors. ``I would be stretching the truth if I said that our business plans anticipated what just happened in the past four to six weeks in the leveraged loans business and the potential impact that it could have on the private-equity market.''

Until last month, demand from investors was so strong that buyout firms were able to borrow with fewer restrictions, using so-called covenant lite securities and pay-in-kind bonds that allow companies to pay off debt by issuing new debt.

Yield Spreads
Investors have put the brakes on the LBO market, rejecting sales to fund buyouts of Auburn Hills, Michigan-based automaker Chrysler Corp. and Nottingham, England-based Alliance Boots Plc, the U.K.'s largest pharmacy chain. The companies failed to sell enough debt, leaving the banks stuck holding the loans while the buyout firms completed their takeovers.

Chrysler's German parent DaimlerChrysler AG last week said it would inject an additional $1.5 billion of debt to support the buyout.
``The high-yield market did a hop, skip and a jump and said, `We're not taking that stuff on those terms,''' said Frederick Joseph, managing director of New York-based Morgan Joseph & Co. and the former chief executive officer of Drexel Burnham Lambert Inc. ``The brokerage firms are getting stuck with some paper and it's going to take a while for it to get digested.''

Momentary `Blip'
The extra premium investors demand to own investment-grade corporate bonds over U.S. Treasuries widened 20 basis points to 128 basis points last week, according to data compiled by New York-based Merrill Lynch & Co. Spreads on high-yield bonds rose 91 basis points to 428 basis points, the highest since May 2005. A basis point is 0.01 percentage point.

``We're clearly going into a time of a very, very limited ability to access the lending market,'' said the 55-year-old Rattner of Quadrangle.
Cadbury had to delay the sale of its U.S. drinks unit because two groups of buyout firms weren't willing to meet the $15 billion asking price. The groups included Stephen Schwarzman's Blackstone Group LP in New York and Thomas H. Lee Partners LP of Boston.

``Some transactions came to market that pushed beyond what the debt markets were willing to do,'' said Scott Sperling, co- president of Thomas H. Lee, in a July 27 interview.

Scrapped Deals
While the pace of leveraged loans is slowing, the market will probably be ``back in business'' by October, Johnny Cameron, head of corporate and investment banking at Edinburgh-based Royal Bank of Scotland Group Plc, told reporters on a conference call on Aug. 3. Royal Bank earned almost $270 million from arranging leveraged loans in the first half, according to Freeman.

``Everybody's thinking about when the music's going to stop and I don't think we've hit that yet,'' said Ilan Nissan, a partner in the New York office of O'Melveny & Myers who works on buyouts. ``We're at a blip at this moment. Many people are saying `Let's take a breather and see what happened.'''

JPMorgan CEO Jamie Dimon, speaking on July 18, told investors that the drop in demand is ``a little freeze.''

That's sending a chill over the investment banks' shares. JPMorgan's stock slipped 11.5 percent in the past month, Deutsche Bank shares dropped 9.4 percent, and Credit Suisse fell 9 percent. Shares of New York-based Goldman Sachs Group Inc. declined 20 percent and Lehman Brothers Holdings Inc. fell 25 percent.

Lost Revenue
Investment banks in the U.S. and Europe are grappling with the loans they've underwritten for buyouts. They're carrying $400 billion of high-risk, high-yield loans they can't get other investors to take, according to Baring Asset Management in London. Companies have scrapped 46 debt deals worth $60 billion since June 22, Baring data show.

``Leveraged deals for private-equity will probably dry up until banks can clear up part of the backlog which will take at least until the end of September,'' said Toby Nangle, who helps manage $37 billion in assets at Baring Asset Management. ``As long as the conveyor belt is jammed, new fee revenues won't be forthcoming.''

Deutsche Bank is one of a group of banks on the line for the funding for KKR's takeover of Alliance Boots. The banks cancelled last week the sale of $2 billion of debt after failing to find investors, increasing the amount of debt the underwriters have been left holding to about $16.8 billion.

``Investors are taking a more cautious approach with respect to leveraged finance,'' Chief Financial Officer Anthony di Iorio told analysts on an Aug. 1 conference call. The bank took a ``not insignificant'' charge in the second quarter to mark down the value of some outstanding leveraged loans, he said.

Business Mix
Leveraged loans made up less than 4 percent of Deutsche Bank's total revenue during the past six quarters. That's less than JPMorgan, which netted more than 7 percent in 2006, and Credit Suisse, which received 7.5 percent of its total revenue from leveraged finance, according to estimates from Standard & Poor's.

As the pace of buyouts slows, not only will banks forgo revenue from underwriting loans, they may miss out on fees from advising on buyouts, according to Richard Barnes, a London-based analyst at S&P. For every dollar a bank earns in fees, it earns a further 50 cents in sales of other products, he said.

``A softening of investment banking performance was inevitable at some point,'' Barnes said. ``We're likely to see that in the third-quarter numbers.''

Financing woes "choking" buyouts

Thomas H. Lee's Sperling Says Markets Are `Choking' on Buyouts
By Jason Kelly and Charles Stein

July 27 (Bloomberg) -- Private-equity takeovers of companies such as Dollar General Corp. and Alliance Boots Plc have piled on more debt than investors are willing to tolerate, Thomas H. Lee Partners LP Co-President Scott Sperling said.

``There are five or six transactions that the market is still choking on,'' Sperling said in an interview today. ``All of those that have been difficult to finance, that may have been a catalyst to what we're seeing.''

Kohlberg Kravis Roberts & Co., the New York-based firm behind the Alliance and Dollar General bids, failed this week to find financing for its buyout of Alliance, the U.K.'s biggest pharmacy chain. That's reflective of a larger repudiation of leveraged buyouts by debt investors demanding to be compensated better for the risks of the loans and bonds.

``We're going to see a pause here,'' Sperling, whose firm is based in Boston, said. ``The folks in our industry are going to sit back and wait for whatever reasonable readjustment there will be.''

About two-thirds of the price tag in the typical leveraged buyout is paid with borrowed money, with the balance coming from cash the takeover firm has raised. Private-equity firms have announced $692.7 billion in transactions so far this year, almost equaling last year's total of $701.5 billion, according to data compiled by Bloomberg.

Buyout firms including KKR are relying on their investment banks to provide loans to finance the deals or reworking the terms of the debt to make them more palatable to investors.

Concern about how private-equity firms will obtain funding is affecting deals that have yet to be completed. Cadbury Schweppes Plc, the world's largest candy maker, said today it plans to delay the sale of its U.S. beverage unit because of the ``extreme volatility'' in the debt markets.

Two buyout groups, one including TPG Inc. in Fort Worth, Texas, and the other New York-based Blackstone Group LP, have expressed interest in the drinks unit, according to people with knowledge of the bidding.

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.

JPMorgan's Jamie Dimon on leveraged buyout loans, and equity bridge loans

"I'm not going to give you specific numbers...because I don't think we disclosed those nor have I seen anyone disclose them. There are loans, and there are bridges, and I want to separate that. The loans are much more secured and senior, et cetera than the bridges...We're involved in a couple, and that's life. That's the world we live in, and we think the loans themselves are good, so we obviously are going to pay a lot of attention to it. If you look at the business, we have our share of ongoing loans, and on the other hand do think there is some deals I have seen out there which are not good. I am not going to mention the names, but we aren't involved in the ones we...think are not good.

Everything you underwrite you do thinking you may own it one day, and so if a lot of the stuff we have out there ends up on our balance sheet, we're still okay. We won't like it, but we'll be okay. We may have to put up some reserves against it, and I should also point out and I will not go into equity bridges other than to say like our private equity positions on our balance sheet, not in the investment bank are $6 billion. That's now under 10% of our equity, so it is really conservative, and the bridge equity stuff would change that number but not dramatically in terms of the company's balance sheet, we're not particularly worried about it. I think equity bridges are a terrible idea. I think they're a bad -- I think they're a bad financial policy. I don't think they're good for the banks. I don't think they're good for the private equity guys, so I hope they go the way of the dinosaur because they're basically a one-sided put on our balance sheet. I also think the street is topped up on them. There is only so much you can do and feel comfortable with. It is kind of silly to take that downside risk and have none of the upside potential."

Another bearish article on the credit cycle

Goldman, JPMorgan Stuck With Debt They Can't Sell to Investors
By Caroline Salas and Miles Weiss

July 17 (Bloomberg) -- Goldman Sachs Group Inc., JPMorgan Chase & Co. and the rest of Wall Street are stuck with at least $11 billion of loans and bonds they can't readily sell.

The banks have had to dig into their own pockets to finance parts of at least five leveraged buyouts over the past month because of the worst bear market in high-yield debt in more than two years, data compiled by Bloomberg show.

Bankers, who just a few months ago boasted that demand for high-yield assets was so great that they would have no problem raising debt for a $100 billion LBO, are now paying for their overconfidence. The cost of tying up their own capital may curb earnings and stem the flood of LBOs, which generated a record $8.4 billion in fees during the first half of 2007, according to Brad Hintz, the former chief financial officer at New York-based Lehman Brothers Holdings Inc.

``The private equity firms, being very tough negotiators, are unlikely to let the banks off the hook,'' said Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York. ``They'll say that's your problem and that's why we're paying you: To take risk.''

As the market began to turn sour last month, Goldman Sachs, Citigroup Inc., Lehman and Wachovia Corp. had to buy $725 million of bonds that Goodlettsville, Tennessee-based Dollar General Corp. was selling to finance Kohlberg Kravis Roberts & Co. purchase of the company for $6.9 billion. All of the securities firms are based in New York, except Wachovia, which is located in Charlotte, North Carolina.

Bonds Tumble
Those bonds are probably worth 94 cents on the dollar, or $43.5 million less than when they were sold on June 28, according to Justin Monteith, an analyst at high-yield research firm KDP Investment Advisors in Montpelier, Vermont. KKR completed the acquisition of Dollar General on July 9.

Bear Stearns Cos. strategists estimate that about $290 billion of deals still need to get funded, including those of Greenwood Village, Colorado-based credit-card processor First Data Corp. and energy company TXU Corp. of Dallas.

The question is ``how much yield are the brokerage firms going to have to eat,'' said Hintz, who is now an analyst at Sanford C. Bernstein & Co. in New York. ``What they've committed to is not current trading rates in the market. If I have a problem it doesn't mean I can't place the problem, but it's going to cause a mark-to-market loss.''

Record Sales
Acquisitions by private equity firms such as New York's KKR and Blackstone Group LP helped push sales of high-yield bonds and loans worldwide up more than 70 percent during the first half of the year to a record $708 billion, according to data compiled by Bloomberg. High-yield, or junk, bonds are those rated below Baa3 by Moody's Investors Service and BBB- by Standard & Poor's.

The investment banking fees generated by LBOs in the first half amounted to almost two-thirds of the $12.8 billion paid by LBO firms to Wall Street in 2006, data compiled by Freeman & Co. and Thomson Financial show. In the race to win deals, the five largest U.S. investment banks more than tripled their lending commitments to non-investment grade borrowers during the past year to $174 billion, according to their regulatory filings.

KKR co-founder Henry Kravis in May called it the ``golden era'' of buyouts at a conference in Halifax, Nova Scotia. The extra yield investors demanded to own junk bonds rather than Treasuries shrank to a record low of 2.41 percentage points in June from the peak of more than 10 percentage points in 2002, according to index data from New York-based Merrill Lynch & Co.

No Escape
For loans rated four or five levels below investment grade, the spread over the London interbank offered rate shrank to 2.12 percentage points in February from more than 4 percentage points in 2003. It has since widened to 2.72 percentage points.

Some bankers even speculated that $100 billion LBO was possible, a scenario that is now ``definitely'' off the table, said Stephen Antczak, high-yield strategist at UBS AG in Stamford, Connecticut. Wall Street's confidence in its ability to finance just about any deal led buyout firms to remove clauses in their purchase agreements that would allow them to back out if their banks couldn't come up with the financing.

Just three of the 40 biggest pending LBOs have an escape clause that lets the buyer back out if funding can't be arranged, said Mike Belin, U.S. head of equity derivatives strategy at Deutsche Bank AG in New York. A couple of years ago, a majority of deals included a financing contingency, Belin said, based on his research.

``If you were a credit officer or a risk manager who said `No' to virtually anything over the last few years you were wrong,'' Hintz said. ``So did they take it too far? Well, yeah. But that's part of any cycle. The issue is did they take it too far and is it going to hurt their earnings.''

Market Cracks
The market for high-yield bonds and junk-rated, or leveraged loans began to crack in June as concerns that LBOs were becoming too risky coincided with a slump in the market for subprime mortgages that caused the near-collapse of two Bear Stearns hedge funds.
Junk bonds lost 1.61 percent last month, the most since March 2005 when General Motors Corp. forecast its biggest quarterly loss since 1992 and the debt lost 2.73 percent, according to Merrill Lynch.

Investors refused to buy bonds to finance purchases of companies including Dollar General and ServiceMaster Co., forcing bankers to either buy the bonds themselves or extend a loan to make up for the securities that weren't sold.

In most deals, investment banks promise to provide loans to the buyer. They then seek other lenders to take pieces of the loans and find buyers for bonds. When buyers vanish, the banks must either buy the bonds themselves or provide a bridge loan to the borrower, tying up capital that would otherwise be used to finance more deals. The banks typically parcel out portions of bridge loans to reduce their risk.

Lending Commitments
Citigroup, the biggest U.S. bank, reported that its securities and banking division recorded an expense of $286 million in the first quarter to increase loan-loss reserves to account for higher commitments to leveraged transactions and an increase in the average length of loans.

Lehman reported on July 10 that its commitments for ``contingent acquisition facilities'' more than doubled in the quarter ended May 31 to $43.9 billion, exceeding its stock market capitalization of $39.1 billion. Lehman said its commitments contain ``flexible pricing features'' that allow it to charge more if market conditions deteriorate.

Goldman Sachs more than doubled its lending commitments to non-investment grade borrowers to $71.5 billion in the year ended May 31.

Citigroup spokeswoman Danielle Romero-Apsilos, Lehman spokeswoman Tasha Pelio and Goldman Sachs spokesman Michael Duvally, either declined to comment or didn't return phone calls.

ServiceMaster Bonds
JPMorgan failed to sell $1.15 billion of bonds for Memphis, Tennessee-based ServiceMaster on July 3. The banks provided ServiceMaster, the maker of TruGreen and Terminix lawn-care products, with a bridge loan to make up for the failed bond sale. ServiceMaster is being bought by private equity firm Clayton Dubilier & Rice Inc. for $4.7 billion.

KKR and New York-based Clayton Dubilier this month completed their $7.1 billion purchase of Columbia, Maryland- based US Foodservice, a unit of Dutch supermarket company Royal Ahold NV, even though junk bond investors refused to buy $1.55 billion of bonds and $3.37 billion of loans to finance the deal, according to estimates from New York-based Bear Stearns.

Deutsche Bank led the bond offering, which included $1 billion of ``toggle'' bonds that would have allowed US Foodservice to pay interest in either cash or additional debt. KKR and Clayton Dubilier relied on loans to complete the deal, according to S&P's Leveraged Commentary and Data unit.

`Beyond Our Risk'
``Many of these things are beyond our risk desires,'' said Bruce Monrad, who manages $1.5 billion of high-yield bonds at Northeast Investment Management Inc. in Boston.

JPMorgan spokesman Adam Castellani, Deutsche bank spokesman Scott Helfman and Morgan Stanley spokeswoman Jennifer Sala either declined to comment or didn't return calls. All the banks are based in New York, except Deutsche Bank, which is in Frankfurt.

Banks can always sell the debt if demand increases. Meanwhile, they may have to report a loss from the decline in value of their holdings, a process known as marking to market.

Banks could also lose money should they have to offer discounts on loans in order to syndicate the deals, said Tanya Azarchs, a banking industry analyst at New York-based S&P.

``I don't think it's going to cause banks to fail or even lead to downgrades,'' Azarchs said. ``But I do think there will be a little indigestion and lower earnings.''

The biggest concern is ``hung deals,'' where a lender is left holding a large loan to a single borrower, said Azarchs. ``Those traditionally in all the prior credit cycles have caused the greatest amount of grief for the large syndicating banks,'' Azarchs said.

`Burning Bed'
In 1989, First Boston Corp., now part of Credit Suisse, made a bridge loan for a buyout of Ohio Mattress Co., the predecessor to Sealy Corp. The junk bond market collapsed before First Boston could refinance the loan, and the securities firm ended up owning a big stake in the bedding manufacturer.

The deal became known as ``Burning Bed.''

``The thing about this business is memories are two seconds long,'' said James Schell, a private equity attorney in the New York office of Skadden, Arps, Slate, Meagher & Flom LLP.

Banks led by Citigroup committed to extend $37.2 billion in credit to fund the purchase of TXU by a group that included KKR, Fort Worth, Texas-based TPG Inc. and Goldman Sachs's private equity group. The financing will comprise $25.9 billion of term loans and $11.3 billion in an unsecured bridge loan.

First Data
Credit Suisse, based in Zurich, is leading banks in the U.S. that have agreed to provide KKR with $16 billion of loans for its $26.1 billion takeover of First Data. The plans include an $8 billion bond sale, which is scheduled for August or September, according to Bank of America Corp.

For firms such as KKR or Blackstone, both based in New York, the tighter credit environment may make their acquisitions less profitable and even change the way they go after future targets. Mark Semer, a spokesman for KKR, declined to comment.

``The underwriters are going to be forced to provide bridge loans and it's getting pretty ugly, but Wall Street deserves to get smacked around a little,'' said William Featherston, managing director in high-yield at J. Giordano Securities LLC in Stamford, Connecticut. ``It's been easy for so long.''

CDS shows Lend Lease risks buyout, says Bloomberg

Lend Lease Buyout Risk Rises, Credit Defaults Swaps Show
By Laura Cochrane

July 17 (Bloomberg) -- Lend Lease Corp., Australia's biggest property developer, may be the target of a leveraged buyout, according to traders betting on the creditworthiness of companies.

Speculation that private equity firms are poised to bid has increased the risk of holding Lend Lease debt to the highest since August 2005. Credit-default swaps are financial instruments based on corporate bonds and loans used to speculate on a company's ability to repay debt.

Buyout firms could buy Lend Lease to break it up, selling businesses including Actus Lend Lease in the U.S. and Bluewater shopping centers in the U.K., said Brent Mitchell, an analyst at Shaw Stockbroking Ltd. A total of $76.7 billion of takeovers have been announced in Australia this year, up from $44.8 billion at the same time last year, according to data compiled by Bloomberg.

``If you took it over there are a couple of quick sales you could do to recoup a lot of what you paid for it,'' Melbourne- based Mitchell said. ``The Actus U.S. military housing business has been fairly successful with a 25 percent market share and they also have a number of high profile U.K. contracts.''

Credit-default swaps based on $10 million of Lend Lease bonds gained 20 percent in the past month to $61,000 at 2 p.m. in Sydney, Bloomberg data shows. This is the highest since Aug. 15, 2005. An increase in the five-year contracts indicates deteriorating credit quality.

Chief Executive Officer Greg Clarke told the Australian Financial Review that Lend Lease hasn't ``had an approach for years,'' the newspaper reported yesterday.

Lend Lease declined to comment today.

Leveraged Buyouts
Private-equity firms have flocked to Australia, which last year scrapped a 30 percent capital gains tax for overseas investors, with the total value of announced takeovers by such firms rising to $15.6 billion from $3.7 billion at the same time last year. Still, interest may wane because of rising borrowing costs after the value of U.S. subprime-mortgage debt plunged.

Pacific Equity Partners and Permira Holdings Ltd. quit a buyout group for Coles Group Ltd., Australia's second-largest retailer, last month and yesterday Kohlberg Kravis Roberts & Co. abandoned a planned debt sale for a Dutch retailer.

Lend Lease is ``under-geared,'' Mitchell said, so buyout firms wouldn't have to borrow as much to take over the company, reducing the chances that rising costs would deter firms from pursuing a deal.

Buyout firms use a combination of their own funds and debt to pay for acquisitions. They seek to expand companies or improve performance before typically selling them within five years to other funds or investors.

Bond Risk
Credit-default swaps were conceived to protect bondholders against default. They pay the buyer face value in exchange for the underlying securities should the company fail to adhere to its debt agreements.

Investors have increasingly turned to the derivatives as cheaper and easier investments than bonds, making the market one of the best gauges of changes in credit quality.

Leveraged buyouts are perceived as bad for bondholders because private-equity firms typically use the company they are acquiring to borrow the money needed to finance the deal.

Lend Lease's debt has the lowest investment-grade ranking of BBB- by Standard & Poor's and Baa3 by Moody's Investors Service. The company has A$1.4 billion ($1.2 billion) of bonds outstanding, Bloomberg data show.

Lend Lease has a market capitalization of A$7.4 billion. The shares fell 1 cent to A$18.54 at 3:35 p.m. in Sydney.

Blackstone takes Hilton Hotels private

Hilton Hotels Sells Itself to Blackstone Group for $20 Billion
By Oliver Staley and Hui-yong Yu

July 4 (Bloomberg) -- Hilton Hotels Corp., the second- biggest U.S. hotel chain, agreed to be taken private by buyout firm Blackstone Group LP for $20 billion, ending more than 60 years as a public company.

Blackstone will pay $47.50 for each share, Hilton said in a statement. That's 32 percent more than its closing price yesterday. Barron Hilton, the son of founder Conrad Hilton and co-chairman of the Beverly Hills, California-based company, will get $990 million for his 20.8 million shares.

The purchase is a record for the hotel industry. Hilton, second in size to Marriott International Inc., has more than 2,800 locations. Blackstone, the owner of the La Quinta chain, is among private-equity firms that are buying hotels to profit from their cash flow and real estate holdings.

``It's a classic Blackstone play: the size, the asset class, the management and the brand,'' said Michael Pralle, who ran General Electric Co.'s GE Real Estate unit, with $59 billion in assets, before resigning in June to pursue other interests.

Including the assumption of debt, the transaction totals $26 billion.

Hilton shares rose $2.18, or 6.4 percent, to $36.05 in composite trading on the New York Stock Exchange before the announcement. Volume of 7.5 million shares was double the three- month daily average.

``It was an exceptionally cheap stock for a very strong portfolio,'' said Amit Kapoor, an analyst at Gabelli & Co. in Rye, New York, which owns about 5 million shares of the company.

No Other Bidders
Shares of Blackstone, which went public last month, rose 45 cents to $29.72. Blackstone owns more than 100,000 hotel rooms in the U.S. and Europe.

Hilton's outgoing Chief Executive Officer Stephen Bollenbach said in an interview that the company has ``seen no other bidders.''

The chain has more than 480,000 hotel rooms worldwide under brands including Waldorf=Astoria and Doubletree.

What started in 1919 as a single property in Cisco, Texas, grew into a hotel dynasty that includes some of the richest people in the U.S.

Forbes magazine estimated that Barron Hilton is worth $1.3 billion. His socialite granddaughter Paris last month served time in jail for parole violations in a drunk- driving case.

The first hotel with the Hilton name opened in 1925 in Dallas. The company sold shares to the public in 1946, and purchased New York's luxury Waldorf=Astoria hotel in 1949.

Biggest Takeover
In 1964, the company spun off Hilton International, then reunited with it last year by buying the lodging unit of U.K.- based Hilton Group Plc for $5.71 billion.

Blackstone's purchase eclipses the 1998 takeover of ITT Corp. by Starwood Hotels & Resorts Trust for $14.6 billion, including debt.

Since the end of 2002, both Hilton and Marriott shares have almost tripled as demand for rooms increased and rates rose. Demand growth slowed this year, and revenue per available room, a measure of rates and occupancy, rose 5.1 percent in the first half of 2007, the slowest pace in at least three years, according to Smith Travel Research.

Hilton's 2006 net income climbed 24 percent to $572 million on revenue of $8.16 billion.

The company in May named Matthew Hart as chief executive officer to succeed Bollenbach, who plans to step down this year while remaining co-chairman through 2010. Bollenbach said it was too early to say what Hart's role would be.

No Property Sales
Blackstone said it doesn't intend to make any ``significant'' property sales as part of the acquisition.

The perceived risk of owning Hilton bonds rose in recent weeks. Credit-default swaps based on $10 million of its bonds increased 12 percent since June 19 to $123,125, according to data compiled by Bloomberg. An increase in the five-year contracts, used to speculate on the company's ability to repay debt, indicates a deterioration in the perception of credit quality.

Buyout firms typically pay for acquisitions with borrowed money and use their cash flow to pay off the debt.

``Blackstone has been a very aggressive investor in the hotel industry,'' said Robert LaFleur, an analyst at Susquehanna Financial in Stamford, Connecticut. ``Hilton is extremely complementary to that portfolio.''

More than 100 real estate funds may raise a record $69 billion this year, according to London-based Private Equity Intelligence Ltd., a research firm. Morgan Stanley in June raised $8 billion for what's the largest high-return real estate fund and Goldman Sachs Group Inc. gathered $4 billion for a similar fund.

Record Funds
Blackstone has raised more than $7 billion for a fund that's slated to top Morgan Stanley's when it closes later this year with about $10 billion of capital commitments.

Financing pledges for the Hilton deal were provided by Bear Stearns Cos., Bank of America Corp., Deutsche Bank AG, Morgan Stanley and Goldman, all of which served as financial advisers to Blackstone. Simpson Thacher & Bartlett LLP offered legal advice.

Hilton was advised by UBS AG and Moelis Advisors, the boutique investment bank opened this week by UBS's former top dealmaker in the Americas, Ken Moelis. Moelis resigned from the Swiss bank in March, though he remained an employee until June 30, after Blackstone began to negotiate its deal with Hilton. He declined to comment.

KKR seeks listing

KKR, Joining Rival Blackstone, to Raise $1.25 Billion in IPO
By Elizabeth Hester and Jason Kelly

July 4 (Bloomberg) -- Kohlberg Kravis Roberts & Co., the company famed for its takeover of RJR Nabisco Inc., plans to raise as much as $1.25 billion in an initial public offering that will help fund its appetite for the biggest buyouts.

The company will use the money to expand and to finance deals, according to its filing yesterday with the U.S. Securities and Exchange Commission. Founders Henry Kravis and George Roberts won't sell any shares. Stephen Schwarzman and Peter G. Peterson, who started rival Blackstone Group LP, took home a combined $2.56 billion in the firm's IPO last month.

KKR, based in New York, has taken part in $200 billion of leveraged buyouts in the past 12 months, data compiled by Bloomberg show. They include the second- and third-largest LBOs, the pending purchases of electricity producer TXU Corp. and First Data Corp., a credit-card payments processor.

``Fund-raising is a time drain,'' said Paul Schaye, managing director of New York-based Chestnut Hill Partners, which finds deals for private-equity firms. ``This means they don't have to go back to the market so much.''.

Thirteen percent of KKR's assets, or $6.8 billion, is ``permanent capital'' that isn't required to be returned to investors and can be redeployed as portfolio companies are sold.

Kravis and Roberts, cousins who founded the firm in 1976, weren't deterred by the 4.1 percent drop in Blackstone's shares since its $4.75 billion offering or the recent decline in the stock of Fortress Investment Group LLC, which went public in February. They also weren't scared off by U.S. legislators' plans to make private-equity firms pay higher taxes or investors who have started to balk at financing buyouts.

Blackstone
The SEC filing shows how far Blackstone, founded nine years after KKR, has outrun the firm by diversifying into real estate and hedge funds. Blackstone oversees $88.4 billion, compared with KKR's $53.4 billion. Net income at KKR rose 12 percent last year to $1.11 billion, half of New York-based Blackstone's profit of $2.27 billion, which was up 70 percent from a year earlier.

Blackstone's shares trade at 14 times earnings, giving the company a market value of $32.2 billion. On that basis, KKR would be worth about $15.8 billion, though it may fetch less given its slower profit growth.

Kravis and Roberts, both 63, hired Morgan Stanley and Citigroup Inc. to manage the offering. The New York-based firms also underwrote Blackstone's IPO. Simpson Thacher & Bartlett LLP is providing legal counsel.

New Name
The company didn't disclose the number of shares it would sell or their anticipated price. The $1.25 billion value given in the filing was an estimate used to calculate the SEC registration fee. The company will be renamed KKR & Co. LP and trade on the New York Stock Exchange under the symbol KKR.

KKR, like Blackstone and Fortress, plans to organize as a partnership, which would allow income to flow directly to shareholders without an additional layer of corporate taxes. Investors could pay taxes as low as the 15 percent capital-gains rate. Blackstone's IPO boosted efforts by lawmakers to propose bills that would require some hedge-fund managers and most private-equity firms to pay tax rates as high as 35 percent as corporations do.

As with Blackstone and New York-based Fortress, KKR's principals will control the company and investors will have little say in how it's run.

Kravis and Roberts started the firm that bears their names with Jerome Kohlberg, their colleague from Bear Stearns Cos. Kohlberg subsequently left and started his own buyout shop, Kohlberg & Co. LLC.

`Barbarians at the Gate'
Kravis made himself famous and pushed LBOs into the spotlight with his hostile takeover of RJR in 1989, a deal whose complications and tensions were chronicled in the book ``Barbarians at the Gate.'' Since that deal, Kravis and Roberts have expanded their business overseas and done ever-larger deals even as competitors pile into the once-quiet buyout world the pair helped create.

KKR's Millennium Fund, closed in 2002, has delivered a net internal rate of return of 41 percent to investors, according to the filing, making it KKR's best-returning pool.

The company paid Wall Street firms $757.9 million in 2006 for takeover advice and financing, the most of any private- equity company, according to estimates by industry consultants at New York-based Freeman & Co. Last year, it raised $5 billion by selling shares in a fund that trades in Amsterdam.

KKR's rapid pace of dealmaking may come back to haunt it as investors hesitate to buy the bonds and loans that takeover firms rely on to finance deals. U.S. Foodservice, a unit of Dutch supermarket Royal Ahold NV, agreed to be bought by KKR and Clayton Dubilier & Rice Inc. in May. The transaction closed yesterday, after bankers on the deal postponed a planned debt offering June 26.

Carlyle, Apollo
Private-equity firms raised a record $210 billion in 2006, a 57 percent increase from the previous year, and the larger pools have pushed them to do more and larger deals. Buyout shops have announced $608 billion of takeovers so far this year.

Leveraged buyout firms use a mix of cash from investors plus their own funds and debt secured on the target they buy to finance deals. They typically seek to expand companies or improve performance before selling them within five years to other funds or investors in initial public offerings.

As KKR, Blackstone and others have grown, founders have sought ways to profit from the value of their firms as well as find new ways to raise permanent capital. Apollo Management LP and Carlyle Group have said they are weighing public offerings of their own.
Hedge funds also are testing the markets. Och-Ziff Capital Management Group LLC, the investment firm run by former Goldman Sachs Group Inc. trader Daniel Och, filed July 2 to raise $2 billion in the largest initial public offering by a U.S. hedge- fund manager.

The New York-based company will borrow $750 million that will be paid to Och and other owners before the share sale. They will reinvest the proceeds into their funds for five years.

Bloomberg special report on KKR

KKR Outspends Blackstone, Instills Profit-First Creed (Update1)
By Richard Teitelbaum

June 29 (Bloomberg) -- It's a great time to be Henry Kravis, as he's quick to remind people.

In April, the buyout mogul is standing in a ballroom of the Waldorf-Astoria hotel in New York, telling AIDS researcher Dr. David Ho, architect Maya Lin and Yahoo! Inc. co-founder Jerry Yang that the private equity industry he helped invent is hotter than ever.

``We're in, right now, the golden age,'' Kravis, 63, tells a gathering of prominent Chinese-Americans and Wall Street executives.

In May, Kravis is up in Halifax, Nova Scotia, saying, again, that the takeover arena has never looked better.

``The private equity world is in its golden era right now,'' Kravis tells a conference of bankers and investors. ``The stars are aligned.''

It's certainly a gilded moment for Henry Roberts Kravis. Almost two decades after his $31.4 billion takeover of RJR Nabisco Inc. rewrote the rules of leveraged buyouts, Kravis is buying companies at a record clip.

Fueled by cheap money that's now getting more expensive, private equity has ripped through public companies and ushered in what George David Smith, business historian at New York University's Stern School of Business, calls a new era of capitalism.

From Jan. 1, 2006, to June 27, Kohlberg Kravis Roberts & Co., the buyout firm Kravis co-founded in 1976 with his cousin George Roberts and one-time mentor Jerome Kohlberg, has announced deals worth $215 billion to acquire all or part of 30 companies, according to data compiled by Bloomberg.

$107 Billion Empire
In that time, KKR, with U.S. offices in New York and Menlo Park, California, outspent rivals Blackstone Group LP, Carlyle Group and TPG Inc.

Behind all of the dealmaking, Kravis and Roberts, also 63, now lord over an industrial empire that dwarfs some of the world's mightiest public corporations. As of May 31, the firm had a hand in 36 companies that together generated about $107 billion of revenue in 2006, according to figures KKR posted on its Web site. That's more than Coca-Cola Co., Microsoft Corp. and Walt Disney Co. put together.

These companies employed 560,000 people, more than either Citigroup Inc. or General Electric Co. In fact, more people work for KKR companies than live in Atlanta, Miami or St. Louis. Now that Blackstone has gone public, KKR may try to do the same, opening Kravis's realm to stock-market investors.

Kravis's Realm
After several of the firm's acquisitions began to sour in the late 1990s, Kravis and Roberts changed direction and tightened their grip on the companies they buy.

Nowadays, New York-based Capstone Consulting LLC, a consulting firm that works exclusively for KKR, measures company performance. KKR demands its managers sink their own money into the companies they run, works its contacts to find pros who can help them, sets performance standards -- and fires people who fail.

``Any fool can buy a company,'' Kravis said at a private equity conference in Frankfurt in February 2006. ``The hard and important part of our job was what we did with the company to create shareholder value once we acquired it.'' KKR executives declined to be interviewed for this story.

From his aerie 42 floors above 57th Street in midtown Manhattan, Kravis straddles the corporate and financial worlds. He's played a role in more than a fifth of the $545.5 billion in buyouts announced this year through June 27.

Setting Records
During that period, Kravis set records on both sides of the Atlantic. After KKR and TPG agreed to buy Dallas-based electric utility operator TXU Corp. in February in a record $45 billion LBO, Kravis and Italian billionaire Stefano Pessina in April agreed to buy British drugstore chain Alliance Boots Plc for 11.1 billion pounds ($22.2 billion) in the largest LBO in Europe.

Today, Kravis's reach extends from North Carolina, where KKR controls mattress maker Sealy Corp.; to Turin, Italy, where KKR owns FL Selenia SpA, which makes automotive lubricants; to Rotterdam, where KKR owns AVR Bedrijven NV, the largest waste management company in the Netherlands. In Europe, KKR owned stakes in or controlled 15 companies as of May 31.

At the center of this empire is an investment committee that meets regularly in KKR's New York headquarters high above Central Park. The group includes Kravis, Roberts and Capstone CEO Dean Nelson and vets proposed deals.

The KKR Way
A second gathering, called the portfolio management committee, also convenes to review KKR's collection of companies and reports from so-called deal teams that put buyouts together.

Twenty-five partners, or members, and more than 65 managing directors, directors, principals and associates are divided into nine industry groups. They split their time between finding takeover targets, working on deals and making sure KKR companies are being run well.

KKR usually assigns two or more of its executives to the board of a company. It deploys Capstone consultants to find ways to cut costs and boost sales.

KKR's 2006 annual review lists 14 senior advisers, including former CEOs Edwin Artzt of Procter & Gamble Co., Paul Hazen of Wells Fargo & Co. and George Fisher of Eastman Kodak Co. and Motorola Inc., who counsel dealmakers and managers and sometimes serve on boards and the portfolio committee. Former Agere Systems Inc. CEO Richard Clemmer joined in June.

RJR Excesses
``KKR is now the best private equity firm at buying companies and then making them better,'' says former partner Scott Stuart, who now runs Sageview Capital LLC, based in Greenwich, Connecticut, and Palo Alto, California, with Ned Gilhuly, another KKR veteran.

It may surprise some people that KKR cares about running companies. Its ill-fated takeover of RJR Nabisco, memorialized in the best seller ``Barbarians at the Gate: The Fall of RJR Nabisco'' (Harper Row, 1990) and a 1993 HBO movie of the same name, made Kravis a poster boy for the ``greed is good'' '80s.

The book recounts how Kravis threw a closing dinner in the ballroom of New York's Pierre hotel, where 400 investment bankers, lawyers and friends dined on lobster, veal with morel sauce and a 3-foot-high (0.9-meter-high) cake adorned with replicas of Nabisco products. The RJR LBO turned out to be a flop, generating an internal rate of return of less than 1 percent, according to a 2001 KKR valuation report.
Buyout Binge

KKR raises money from investors, typically public and corporate pension funds, and then leverages that cash with borrowed money to make acquisitions and magnify returns. For example, KKR may invest $1 of equity for every $9 it borrows.

Buying companies is the easy part. The harder part is improving them so they pay down debt more quickly and then cashing out at a profit by selling them to someone else, usually the public, in the form of an initial stock offering, or directly to another company or group of investors.

Hardly a day goes by without another marquee brand getting gobbled up by private equity these days.

From Jan. 1, 2006, to June 27, 21 companies in the Standard & Poor's 500 Index announced their sale to private equity firms. Private equity buyouts accounted for $1.2 trillion, or 20.5 percent, of the record $6.1 trillion in mergers and acquisitions announced worldwide during that period.

Now, with interest rates climbing, life could get tougher for the private equity crowd, which borrows heavily to finance acquisitions. Benchmark 10-year U.S. Treasury rates climbed to 5.08 percent on June 27 from 4.54 percent in mid-March.

Fear and Greed
A sustained rise in rates or a decline in stock prices would turn up the heat on KKR -- and the managers who run its companies.
Buyout firms have already hit a rough patch. Blackstone stock, initially priced at $31, fell as low as $29.13 on June 27. The stock was trading at $30.03 in New York today. Carlyle Group this week cut the size and price of an IPO of a fund that invests in bonds backed by mortgages as damage from the U.S. real-estate slump spread.

How KKR manages its companies is more important than ever. The firm usually lines up top people and makes them scared to fail. Joseph Welch, chief executive officer of electric utility company ITC Holdings Corp., says KKR ensures its managers stay focused on the bottom line by making them invest in their own companies.

When KKR bought Novi, Michigan-based ITC in 2003, it offered Welch a chance to run it -- provided he put about $1.5 million into it. Welch ended up emptying his savings account, mortgaging his house and taking out a loan.

``KKR didn't want to have trouble sleeping at night,'' Welch, 58, says. ``They did that by making sure I had trouble sleeping at night.''

No Losers
KKR sets benchmarks for everything from the amount of scrap produced to safety records and then holds managers accountable.

At Princeton, New Jersey-based Rockwood Holdings Inc., which makes specialty chemicals and advanced ceramics, CEO Seifi Ghasemi, 62, used such benchmarks to turn around the company during the 2001 U.S. recession. He fired 10 percent of Rockwood's workforce.
``We are trying to make people rich -- and rich people even richer,'' Ghasemi says.

KKR has zero tolerance for money losers. Eckard Heidloff, CEO of Paderborn, Germany-based Wincor Nixdorf AG, which manufactures automated teller machines, discovered that when Gilhuly told him the firm was considering selling a Wincor division that was in the red.
Kravis's team makes sure managers understand that customers -- not KKR -- will pay down debt.

The Capstone Edge
Marc Tellier, CEO of Montreal-based Yellow Pages Group, which distributes telephone directories across Canada, says Capstone helped improve a system that employs the Canadian consumer price index and a half dozen other variables to better price ads and stoke sales.
Power grids, advanced ceramics, ATMs, Ottawa telephone directories -- it's all a long way from the world of Henry Kravis. He and his wife, economist Marie-Josee Kravis, form one of New York's ultimate power couples.

A regular at black-tie galas, Henry serves on the boards of the Metropolitan Museum of Art, Mount Sinai Medical Center, Columbia University's Graduate School of Business and Rockefeller University. Marie-Josee, a senior fellow at the Washington-based Hudson Institute, is president of the Museum of Modern Art. Roberts, whose wife of 35 years died in 2003, keeps a lower profile than his cousin. Kohlberg, 81, left after a falling-out in 1987.

30 Percent Returns
The private equity boom that Kravis and Roberts are fueling has implications not just for Wall Street but increasingly for every executive, investor and retiree. U.S. public and corporate pension funds are looking to boost returns so they can keep their promises to aging workers.

Kravis's aim is to earn his investors fatter returns than they could get in the stock market.

The $245 billion California Public Employees' Retirement System says on its Web site that from its start in 2001, KKR European Fund LP generated a 30.7 percent internal rate of return through December 2006. KKR Millennium Fund, which was started in 2002, posted a 39 percent internal rate of return.

Back in the '80s, private equity firms produced most of their investment returns via the leverage they employed to acquire companies. Now, they're making more of their money by overhauling business practices and improving productivity.

For their efforts, buyout firms collect fees in all shapes and sizes. Firms such as KKR typically charge management fees of 1-2 percent and collect 20 percent of any capital gains when they sell a company.

Fees, Fees, Fees
On top of that, KKR collects fees from its companies for advice on mergers and acquisitions as well as for management consulting and other services.

When KKR bought Sealy from a group led by Boston-based Bain Capital LLC in 2004, for example, Kravis's firm and Bain shared $31.8 million of M&A advisory fees.

Do private equity firms earn their money? NYU's Smith, co- author of ``The New Financial Capitalists: Kohlberg, Kravis Roberts and the Creation of Corporate Value'' (Cambridge University Press, 1998), says well-run buyouts have helped liberate companies from the rubber-stamp boards that have long dominated much of corporate America.

``Most boards at public companies have been captives to the CEO,'' he says.

Michael Chu, a former executive and limited partner at KKR, says managers at public companies can muddle along, even prosper, simply by not rocking the boat. That doesn't work at KKR companies.

The LBO Effect
``You don't have the luxury of managing issues at the margin,'' says Chu, a founder of Buenos Aires-based Pegasus Venture Capital.
``If the market changes, you change the strategy,'' he says. ``If the CEO doesn't work out a year into the deal, you never shy away from the tough questions. You change the CEO.''

Measured by stock performance, LBOs have made many companies better, according to a 2006 study by Jerry Cao, a doctoral candidate at Boston College, and Josh Lerner, a professor of investment banking at Harvard Business School.

The pair examined almost 500 companies that went private in LBOs and subsequently went public again from 1980 to 2002. They found that these companies beat their IPO peers in the stock market: Companies that had undergone LBOs posted an average, cumulative three-year return of 57.9 percent compared with 20.5 percent for conventional IPOs and 33.4 percent for the Standard & Poor's 500 Index.

Who Gets Hurt
Lerner says the disciplining power of an LBO forces managers to make tough decisions.

``There is a process of refocusing the company, disposing of divisions that aren't central to its mission,'' he says.

Even so, when KKR pulls the levers, someone usually gets ground up in the gears. By leveraging companies, KKR encourages managers to cut costs and, often, that means jobs.

KKR bought Evansville, Indiana-based Accuride Corp., which makes truck parts, in 1997 and sold the last of its shares in early June. In April, the International Brotherhood of Teamsters agreed to lay off 64 of about 350 workers at Accuride's Plant No. 1 in Elkhart, Indiana.
Matt Sandefur, a machine operator who works on brake drums for big rigs at the plant, says managers have frozen his pay for 2007, doubled health insurance deductibles and cut coverage. He's looking for a new job.

New Concern
``I say KKR hates unions,'' Sandefur, 41, says. ``I used to feel secure in my job.''

Workers aren't the only ones worrying these days. As private equity deals get bigger and bigger, some investors see trouble brewing. Wall Street, after all, tends to get carried away. The LBO boom of the '80s ended with an implosion in the junk bond market and a wave of corporate bankruptcies.

``Everybody thinks private equity is the panacea,'' says Jim Leech, senior vice president of Teachers' Private Capital, part of the Ontario Teachers' Pension Plan. ``In our opinion, it's getting scary.''

Lately, acquisition prices have been rising along with borrowing costs. Competition for deals pushed the average price paid for companies in LBOs to 8.5 times cash flow in the fourth quarter of 2006 from 6.4 times in 2001, according to S&P.

``It's a case of a lot of money chasing after deals,'' Chu says. Ultimately, private equity returns are likely to falter, he says. ``Maybe you don't get 25 percent returns; you get 12 percent or 10 percent,'' he says.

Regal Debacle
Kravis and Roberts have been through rocky times. Starting in the late '90s, KKR stumbled as a string of its companies began to fail, most notably Knoxville, Tennessee-based Regal Cinemas Inc., which filed for Chapter 11 in 2001.

It was a costly mistake that changed the way Kravis and Roberts operate. KKR had led a buyout of the movie theater chain in 1998 for $1.58 billion, only to see its value plummet amid a glut of multiplex theater construction.

``George Roberts and I sat down and said, `Look, we've got to change the way we're doing business,''' Kravis said in April at the Waldorf-Astoria, where he was addressing the Committee of 100, a group of Chinese-American leaders that includes cellist Yo-Yo Ma and architect I.M. Pei.

After the Regal Cinemas debacle, KKR created its investment and portfolio management committees, organized its dealmakers into industry groups and formalized 100-day business plans: playbooks that spell out what actions are supposed be completed by specific dates in the early months of a buyout.

Harnessing Greed
Kravis tapped Nelson, a senior vice president of Boston Consulting Group Inc., to build Capstone in 2000.

To run its companies, KKR harnesses the forces that drive financial markets: fear and greed. At ITC, all of the executives that Welch hired also had to invest their own money in the company.

The son of a Kansas laborer, Welch joined Detroit-based DTE Energy Co.'s predecessor, Detroit Edison, in 1971, fresh out of the University of Kansas, where he earned a bachelor's degree in electrical engineering.

When he was put in charge of DTE's power transmission infrastructure in 1999, Welch discovered that it was dilapidated. Transmission corridors were overgrown with vegetation, generators were leaking fuel and breakers were rusted, he says.

``The thing had been lost in the amorphousness of the parent, and it had been run ad hoc,'' Welch says of ITC. Underinvestment in the power grid is a national disgrace, he adds.

ITC Vision
Welch had a vision: A separate ITC would have the incentives to invest in the grid, improve reliability -- and help solve America's energy crisis by enabling renewable energy to be transmitted efficiently. He urged DTE to establish ITC as a separate unit. DTE did, and decided to sell it.

KKR, New York-based Trimaran Capital Partners, the state of Michigan and ITC management teamed up to buy ITC for $610 million. The $650 million financing package consisted of 35 percent in cash and $425 million of term loans.

Regulators wanted ITC to be untangled from its parent in 12 months. At first, Welch had a steel desk -- and no chair or corporate checking account. The local OfficeMax wouldn't even let him buy paper clips on credit.

Welch and KKR set to work. Their first task was to hire 17 executives. KKR required all of them to sink their own money into ITC. Welch offered Edward Rahill, director of planning and corporate development at DTE, a job as chief financial officer - - and gave him less than 24 hours to think it over.

`Long-Term Story'
Rahill, 54, says he ultimately joined for the opportunity to help fix America's crumbling power grid.

``It's the greatest team-building exercise you can have,'' Welch says. ``And that, fundamentally, in my mind, is why KKR is so damned successful: They invest in and motivate people -- they align people.''

Stuart, the former KKR partner, was Kravis's point man on ITC. His job was to explain the company's business plan to state and federal regulators.

``It was a great long-term story,'' says Stuart, 48. ``The grid in the U.S. needs a lot of investment to handle the demands.''

KKR put its contacts to work. Deloitte & Touche USA LLP, KKR's preferred accounting firm, helped ITC set up a new accounting system within four months. London-based Willis Group Holdings Ltd., a former KKR company, arranged insurance for ITC transmission lines.
Top of the List

Law firm Simpson Thacher & Bartlett LLP, whose chairman, Richard Beattie, worked with Kravis on the RJR Nabisco buyout, provided legal advice.

``When you're a KKR company, people come in and put you at the top of their lists,'' Welch says.

Rahill agrees. ``You get the A teams, no if's, and's or but's about it,'' he says.

ITC went public at $23 a share in July 2005. According to a May supplement to KKR's 2006 annual review, the firm initially invested $128.7 million. By the time KKR sold its last shares in February for $316.7 million, it had generated gross proceeds of $664.4 million, or five times its invested capital.

ITC shareholders have made money, too. Through June 27, the stock had posted an annualized return of 40.4 percent since the IPO. Welch's stake, 1.7 percent as of May 14, was worth $30 million as of June 27.

Like Welch, Heidloff at Wincor Nixdorf, the ATM maker, sees KKR as a liberator.

Wincor Buyout
Heidloff joined a predecessor of Wincor Nixdorf in 1983, after graduating from the University of Paderborn with a degree in business administration.

During the '90s, the company missed out on international growth opportunities as part of Munich-based Siemens AG, Heidloff says. While Wincor had 60 percent of the German ATM market, its global share was 8 percent, he says.

Because Siemens was organized by geography and along product lines, country managers could reject Wincor proposals to expand outside Germany.

``I spent two days a week convincing headquarters and country managers to get approval to grow the business,'' Heidloff, 50, says.
In 1999, Heidloff, then CFO, and Karl-Heinz Stiller, CEO at the time, drafted a plan with Siemens's management to set Wincor free. Siemens put Wincor on the block.

KKR teamed up with Goldman Sachs Group Inc. to buy Wincor Nixdorf for 736 million euros ($789 million) in late 1999.
Flying to Frankfurt

As a condition, KKR demanded Heidloff and Stiller stay on. KKR bought 71.3 percent, Goldman Sachs bought 17.8 percent and more than 100 Wincor executives purchased a total of 10.9 percent.

``We didn't want a situation where just two or three people got rich,'' says Heidloff, who became CEO when Stiller retired this year.
In the beginning, KKR's Gilhuly and Johannes Huth, then a managing director, flew weekly to Frankfurt to check on the progress. It was impressive from the start, with cash flow rising 11.2 percent annually between fiscal 2000 and fiscal 2003.

When it became clear that Wincor's retail computer unit was losing money, Gilhuly, Huth and their counterparts at Goldman Sachs told Heidloff it was time to consider a sale or other options.

``They really wanted to be in that business,'' Gilhuly says. ``We turned up the heat.''

Model LBO
The Wincor unit sharpened its focus on high-margin software components and emphasized consulting services. The division, which had a 7.6 million euro loss on a cash flow basis in 2000, earned 12.8 million in 2002.

``They turned out to be an exceptional team,'' Gilhuly, 47, says.

Heidloff says it was a model LBO. ``If you do a budget and deliver every quarter, your life is very easy,'' he says.

Wincor Nixdorf went public in a May 2004 IPO that valued the company at about 1 billion euros. KKR reduced its stake to 28.8 percent.
Heidloff and other Wincor executives largely held on to their stock, figuring KKR was selling too early. They were right. Through June 27, Wincor stock had posted an annualized return of 47.9 percent since its IPO.

Even in the post-Regal Cinemas era, KKR has run into trouble. When acquisitions go sour, KKR steps in -- fast.

Changing Tack
After KKR bought Rockwood Holdings from Laporte Plc in November 2000 for $1.18 billion, putting down $282 million in cash and financing the rest with a mix of loans, a U.S. recession sent prices of Rockwood's chemicals sinking. By late 2001, the company was losing money.

KKR tore up its business plans for Rockwood's various units and drew up new ones. It dispatched Capstone's Eric Daliere and Nelson to set new benchmarks and improve productivity at scores of factories around the world.

KKR was running Rockwood with what it considered interim management. Kravis wanted a new CEO and zeroed in on Ghasemi, who was a former executive director at National Iranian Steel Industries, the country's state-run steel company under the late shah. Ghasemi fled Iran after the 1979 Islamic Revolution and eventually went to work for Redditch, U.K.-based GKN Plc, a maker of car and airplane parts.

Shaking Up Rockwood
When Ghasemi walked into Rockwood's Princeton headquarters in October 2001, a fellow executive apologized for not having prepared an office for him.

``I don't need an office,'' Ghasemi recalls saying.

Then the executive told him that Rockwood hadn't lined up a secretary for its new CEO either.

``I don't need a secretary -- and neither do you,'' Ghasemi said.

Before long, the executive, and his secretary, were gone.

Ghasemi, who has a master's degree in mechanical engineering from Stanford University, says he spent as many as 28 days a month on the road. He visited Rockwood plants around the world to find ways to squeeze costs and boost efficiency.

At a factory in Gonzalez, Texas, he went through plant schematics and figured out that the company could rearrange production lines to operate with fewer people. He ultimately fired 400 people companywide, or 10 percent of the workforce.

``I'm not too shy to say Rockwood exists to make money,'' says Ghasemi, who wears a lapel pin inscribed with Rockwood's motto: ``Cash, Customers, Commitment.''

Ghasemi knew how to fire up a sales force.

Darwinian Management
He offered them a 10 percent cut of any price increases they negotiated on Rockwood chemicals. Lo and behold, prices stopped falling.
The overall strategy was Darwinian. The company would unload any division that wasn't No. 1, No. 2 or No. 3 in its field.

Ghasemi freely tapped into KKR's brain trust. KKR had explored acquiring Frankfurt-based engineering company MG Technologies AG. Ghasemi and KKR used that knowledge when deciding to buy MG Technologies' Dynamit Nobel chemicals unit in 2004 for $1.98 billion. Rockwood and KKR then worked to unload part of that company in 2006.

With Capstone's help, Ghasemi devised spreadsheets so plant managers could keep track of which customers bought what chemicals as well as customer complaints and product returns.

Each month, Ghasemi now thumbs through a thousand-page printout comprising such stats from every plant around the world.

KKR Clout
``That's how you know what's going on at a company,'' Ghasemi says. In all, KKR poured $572.6 million into Rockwood in exchange for common and preferred stock, much of that going to bankroll the purchase of Dynamit Nobel.

In Rockwood's August 2005 IPO, KKR garnered $36.7 million of the proceeds from the redemption of convertible preferred stock it held, plus sundry fees. It also shared $131.9 million with Credit Suisse Group's DLJ merchant bank unit, which had invested $159.4 million in the Dynamit Nobel purchase.

The offering left KKR with 51 percent of the company, which was worth $1.37 billion on June 27. As of that date, the stock had returned an annualized 38.1 percent since the IPO.

KKR uses its clout to help its companies recruit executives in a hurry. After KKR and the Ontario Teachers' Pension Plan bought 90 percent of Yellow Pages Group in November 2002 for 3 billion Canadian dollars ($1.92 billion), KKR's Joseph Bae and Alexander Navab retained Marc Tellier as CEO.

KKR bought Yellow Pages from BCE Inc., Canada's largest telephone company, where Tellier had spent his entire career.

Luring Executives
In late June, three separate groups of investors, one of which included KKR, had either submitted bids for BCE or were considering doing so.

Tellier, 38, says he relied on Capstone and KKR to fix Yellow Pages.

``This was not a well-run business,'' Tellier says. One obvious sign: The Yellow Pages directories bore blue covers because blue was BCE's corporate color.

``The critical element was to get the management team in place,'' says Tellier, whose father, Paul, served as CEO of Bombardier Inc. and Canadian National Railway Co.

Tellier needed a head of sales, a chief information officer, a chief financial officer, a general counsel and a head of human resources. Bae and Navab, members of KKR's communications team, gave five executive search firms one week to come up with plans to find the executives.

Tellier and KKR reviewed the proposals and hired Toronto- based Caldwell Partners International. Four weeks later, Yellow Pages Group had its executives.

Spurring Sales
Tellier says Capstone's Nelson and other consultants helped the company zero in on its customers, set prices for Yellow Pages advertisements and ramp up sales.

Nelson suggested Tellier use a range of variables, from the Canadian CPI to the directories' market penetration in a given region, to help set ad prices. Capstone helped upgrade management software so executives could track sales more effectively.

Today, Tellier can monitor weekly sales by province, sales manager or salesperson. With a click of his computer mouse, he can locate the person who can tell him why sales are up or down in a particular area or category.

Salespeople also began tracking how customers responded to pitches over time. Yellow Pages urged sales reps to push larger ads, which cost $156 a month, rather than smaller ones, which cost $24.

Another IPO
Tellier increased the proportion of salespeople who make face-to-face pitches rather than phone calls. Reps who used to sell six area directories sometimes had the number cut to, say, three. That way they'd be less likely to let sales lag in any one sales region.
Once a week, Tellier parks his GMC Yukon at a local coffee shop and hits the road with one of his 500 salespeople.

``You've got to understand the psyche of a small-business owner,'' Tellier says. ``One hundred percent of the dialogue is helping the customer be more successful.''

Yellow Pages Group went public in July 2003, selling its equity via Yellow Pages Income Fund, an income trust. The structure is similar to that of a real estate investment trust and enables companies to pass on earnings untaxed. The deal took advantage of investors' hunger for high-yielding securities at the time and valued Yellow Pages at C$4.7 billion. Through June 27, Yellow Pages units had returned an annualized 14.4 percent since trading began.

`Having a Ball'
Kravis and Roberts, each man now in his seventh decade, are more powerful than they've ever been. Stuart, the KKR veteran, says his former bosses show no sign of slowing down.

``My sense is, they're having a ball,'' he says.

No party lasts forever. Kravis captured the euphoria of his golden age last November, before financing costs began rising, when he addressed newly minted partners of Goldman Sachs.

At the Ritz-Carlton hotel in lower New York, Kravis told the crowd that KKR and Goldman had worked together and made money together for three decades. Their lucrative partnership would endure, he said.

Kravis paused. ``Just don't do anything to screw it up,'' he added. The partners laughed. As the deals -- and potential dangers -- of the private equity boom keep multiplying, Kravis might want to heed his own advice.