Is the LBO "put" era drawing to a close?

NEW YORK Thu Jul 26, 2007 4:24pm EDT

NEW YORK (Reuters) - So much for the LBO put.

The notion that this market had a nearly impenetrable floor on the bet that everything from big box retailers to media conglomerates were in the sights of some private equity firm helped lift Wall Street stock indexes to record after record.

But that looks like it is about to change.

As credit becomes more expensive and less readily available, the probability of companies being "taken out" is plummeting, said Richard Bernstein, chief investment strategist at Merrill Lynch.

He says that with financial market volatility spiking upward, equity investors should stop looking backward and cease discussing so-called "takeover premiums" -- when a stock rises above its value, because investors think it may be about to be bought out.

"The rationing of credit means equity investors should discontinue their speculation regarding takeovers and LBOs," Bernstein wrote in a note to clients.

Investors are already backing out of some stocks which had been touted as targets. The retail sector, for example, which had attracted takeover premium-seekers like bees to honey has seen huge losses as worries about financing of deals grew.

The S&P retail index .RLX fell 3.4 percent on Thursday, while department store chain Macy's Inc. (M.N) -- which this month has had buyout speculation swirl around it -- dropped 6.6 percent.

"That whole speculative theme on LBOs and takeouts that was partially driving the market a couple of months ago, that bid is definitely gone from the market," said Sam Rahman, portfolio manager at Baring Asset Management Inc. in Boston.

The term LBO "put" was coined to reflect that any company whose balance sheet and stock price suggested it could be a target would see its stock rise. That meant what should be bad news for a company was often perceived as good news if it made a buyout more likely.

So the effect was the same as if investors had bought an actual put option -- which enables investors to sell shares at a set price even if the actual price falls below it.

A similar phenomenon -- dubbed the "Greenspan put" -- was seen in the 1980s and 1990s, when investors seemed to expect that the Federal Reserve would always be around to sort out any crisis.

That means stocks that have traded as attractive on the basis they could be the target of buyout firms are increasingly less likely to benefit from the private equity "put," or the LBO valuation "floor."

Worries about financing for deals escalated this week and drove a global sell-off in shares on Thursday as investors were spooked by delayed financings for the buyouts of DaimlerChrysler AG's DCXGn.DE Chrysler Corp. and UK health and beauty chain Alliance Boots AB.UL.

Analysts said that deals would continue to get done, but noted that there would simply be a higher threshold as to how much debt could be raised for a deal -- and at what price.

"The market's mandate is simply the repricing of money for leveraged buyouts. There is still a tremendous amount of global liquidity. It's not as if the baby is being thrown out with the bathwater," said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.

But even if takeover speculation were to no longer lend as much support to the market as it has become accustomed to, said Baring's Rahman, "there are enough things to support the market if you look out beyond the clutter. Earnings have been OK this quarter and the market's valuation is still not that bad," Baring's Rahman added.