DEALTALK-Tribune may be tip of bankruptcy iceberg among LBOs

NEW YORK Mon Dec 8, 2008 7:38pm EST

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NEW YORK Dec 8 (Reuters) - Debt-laden companies bought with cheap money during the private equity boom are under increasing stress as the U.S. economy worsens, and more are expected to follow media company Tribune into bankruptcy.

The collapse of the publisher of the Chicago Tribune and Los Angeles Times is the biggest yet among companies taken private in the leveraged buyout boom that ground to a halt in mid-2007, but it's unlikely to be the last.

While not a private equity deal, the buyout of Tribune by employees and real estate mogul Sam Zell was one of those that epitomized the credit boom. The company took on about $8 billion of additional debt when it went private.

"This process of deleveraging America, whether financial institutions or Tribune, will be a long, slow and painful process," said Duke University Law School Professor James Cox. "That's what's going to prolong this recession."

He said there were particular concerns over deals in industries whose fortunes rise and fall with the economy and those which may be headed for extinction.

"There are a lot of other deals, transactions, out there that tend to do well when the economy is expanding but really hit the floor when it's not," said Cox.

Retailers have been particularly hard hit. Linens 'n Things, bought by New York buyout firm Apollo Management, filed for bankruptcy in May, and department store chain Mervyns Holdings LLC, previously acquired by Cerberus Capital Management LP and Sun Capital Partners, announced plans to liquidate in October.

"I think undoubtedly we will see more bankruptcies of private equity-backed firms, but also regular operating firms too," said Josh Lerner, professor specializing in private equity at Harvard Business School. "What's harder is to say whether the private equity ones are more likely to (fail)."

He cited a study released earlier in the year showing that a small percentage of deals over the history of the private equity industry worldwide have ended in a bankruptcy or a distressed reorganization. Lerner led the research team on the study.

However, failure rates appear to be far greater for megadeals concluded at the peak of buyout booms, Lerner said.

He cited a 1993 study which concluded that of the 66 largest deals done at the peak of the 1980s buyout boom, 38 percent experienced financial distress and 27 percent defaulted on debt repayments, often in conjunction with a Chapter 11 filing.

Loose loan covenants could help some private equity firms stave off trouble, although it is debatable whether these just prolong the pain. These covenant-light deals, popular during the boom, lack the traditional restrictions on borrowers, while pay-in-kind deals, also called PIK-Toggle, allow firms to defer interest payments in favor of issuing more debt.

UNDER STRESS

A number of private equity firms' portfolio companies are trading at distressed levels in the credit default swap market, indicating concern in the market about their future.

Harrah's Entertainment, which operates nearly 40 casinos across the United States, was bought by Apollo Global Management and TPG Capital LP [TPG.UL] at the peak of the leveraged buyout bubble. Now Harrah's has put most of its development plans on hold as it grapples with a soft economy and a heavy debt load.

The cost of protecting Harrah's debt against default is 66.5 percent of the sum insured upfront, or $6.65 million to insure $10 million in debt for five years. Swaps on real estate firm Realogy, owned by Apollo Management, is trading at around 76.5 percent.

Swaps on Station Casinos are also trading at extremely distressed levels, costing 75 percent of the amount of debt insured.

These levels indicate high concerns that the companies risk bankruptcy if they are unable to reach agreement with their lenders to restructure their debt.

Realogy, which owns real estate brokerages including Century 21, ERA and Coldwell Banker, is being sued by activist investor Carl Icahn over a debt deal announced last month.

Icahn, who owns Realogy bonds through High River, thinks the deal unfairly pushes his senior bonds to the back of the repayment line, according to the lawsuit, filed in a Delaware court.

Gaming company Station Casinos, bought in a management-led-buyout, is trying to exchange its debt for longer maturities, though bondholders last week rejected the offer as "deficient."

This leaves the company in a difficult situation as it may not be able to afford to offer more compensation to bondholders without tripping terms in its bank loans, which Station is at risk of violating by year-end, KDP analyst Barbara Cappaert said in a report last week.

TPG and Apollo declined to comment. (Reporting by Megan Davies; editing by Richard Chang)

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