| NEW YORK
NEW YORK Dec 8 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
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
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.
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
Swaps on Station Casinos are also trading at extremely
distressed levels, costing 75 percent of the amount of debt
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
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)