Home Depot deal transplant better than death: James Saft

LONDON (Reuters) - Like a heart transplant, the recasting of the Home Depot deal is a lot better than the alternative.

But it also shows how companies, banks and buyout firms alike are going to be enjoying a lot less fat in their diets in the future.

Lower prices for companies and corporate assets, lower margins for private equity funds, lower investment banking revenue and tough tests still to come for selling down buyout debt.

Home Depot said on Tuesday that it will reduce the price of its supply division to $8.5 billion, a cut of about 17.5 percent.

Home Depot will also take a 12.5 percent equity stake in the deal for a price of $325 million and will guarantee $1 billion of senior secured debt for the new company.

Buyout firms Bain Capital, Carlyle Group and Clayton, Dubilier & Rice will each kick in an additional $150 million in equity, according to earlier reports.

It also seems highly likely, not to mention sensible, that the buyout firms will be forced to pay higher rates of interest on the deal's debt and to submit to more restrictions in how they can run the unit's finances.

So, enough pain to go around then.

And be very clear, the smart, aggressive players around the negotiating table only agreed a restructuring this radical because they realized the alternative was very grim.

A busted deal would have dealt serious blows to the reputations and interests of those involved, including banks JPMorgan, Lehman Brothers and Merrill Lynch.

It also would have called into question the viability, and crucially for the banks, the value of the debt backing the $350-400 billion of such deals now making their way through the system, and much of which debt banks are now stuck with, at least temporarily.

HOME DEPOT DIFFERENT, BUT NOT DIFFERENT ENOUGH

Some analysts and observers have been careful to stress the differences that may mark the Home Depot transaction out from the hosts of others.

It is true that the Home Depot supply deal was hit doubly: once by having been structured in a credit market that now no longer exists and secondly because it operates in a part of the economy - housing - that has been hit hard.

And the company seems to have had its heart set on the share buyback program it intends to fund with the proceeds of the supply deal, perhaps making it a more willing negotiator than some other sellers.

But it would be foolish to think this is just a story about a company in a hard-hit industry.

The deal implies lower values for a lot of other assets out there as well. If you need evidence that the "private equity put," the idea that company valuations will be supported by bids from financiers if they fall too low, is on the decline, this is it.

Other deals may need to be renegotiated and ones as yet unborn will be at lower prices.

This also puts a crimp in the rates of return private equity funds can expect. While the price has been cut, the deal also now includes Home Depot's 12.5 percent equity stake as well as the reported new $450 million from the sponsors.

The cost of financing is also likely to have risen and the new company will have to live within more conservative guidelines, if bankers were successful in winning more restrictive language and better terms in the loans backing the deal.

And while the banks now benefit from those same higher rates and covenants, they still have to sell the loans on to others, a process not without risk, as recent events have shown.

This may be the most important test in the wake of the re-done deal.

(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)