Wall Street seeks protection in future LBO deals

NEW YORK (Reuters) - Private equity deals are headed for an overhaul as Wall Street investment banks worry about getting caught in another failed leveraged buyout or a debt-offering dud.

After raking in more than $30 billion in private equity fees on more than $1 trillion worth of acquisitions in the last two years, banks got hung up not only on leveraged buyouts that fell apart, but also on deals that debt buyers spurned.

For example, Merrill Lynch & Co Inc's MER.N leveraged loan portfolio took a nearly $1 billion hit in the third quarter, while Goldman Sachs Group Inc (GS.N) took a $1.71 billion write-down on its portfolio.

With the credit crunch still taking its toll across financial markets, bankers want to avoid getting caught naked on the next private equity bid.

Such deals are no longer about trust, a handshake and a loosely worded merger agreement. Rather, deal documents will be heavy with airtight language and protections for all parties against material changes, lawyers say.

While no one can say when leveraged buyouts will pick up again, dealmakers say one thing is clear: Future buyout agreements will bear little resemblance to the ones inked during the private equity industry's three-year takeover spree.

In fact, experts say the LBOs of tomorrow will bring back many elements of the past, including financing conditions that make it easier for banks to withdraw from a deal.

Conditions that give suddenly skittish buyers an easy exit are out, while bank-friendly terms and more-specific clauses on material adverse changes are in.

"Deals will be fully committed, but with traditional market outs," said Robert Kindler, Morgan Stanley's vice chairman of investment banking, referring to provisions that allow banks to back out of deals without penalty if certain debt or credit market conditions exist.

Kindler points out that market outs were standard before the buyout boom kicked into gear in 2005. The private equity purchase of retailer Toys R Us that year, for instance, contains certain financing conditions.

But 2005 was also when credit markets turned frothy, and banks began skipping the protections for the sake of winning over deep-pocketed private equity clients.

The re-introduction of financing conditions heightens the pressure on buyout firms, particularly big ones, to put more cash, and less debt into deals -- a strategy that is expected to reduce industry investment returns.

"I think generally, when the market returns, as it inevitably will, what you're going to find are lower prices being paid for assets because the amount of leverage is going to be lower," Kindler said.

BACK TO BASICS

The back-to-basics approach is already under way.

Hellman & Friedman's $1.8 billion agreement in October to buy manufacturer Goodman Global Inc GGL.N contains at least one financing condition: The company's year-end earnings before interest, taxes, depreciation and amortization cannot come in below $255 million.

By contrast, Cerberus' CBS.UL $4 billion takeover deal with rental company United Rentals Inc (URI.N) in July simply says: "The merger agreement does not contain a financing condition to the closing of the merger."

Cerberus ended up backing out of the deal.

The $25 billion leveraged buyout of student lender Sallie Mae (SLM.N) by a group led by J.C. Flowers also fell apart. Central to that dispute was the consortium's argument that a material adverse change had occurred in the company's business because of a credit-market squeeze and legislation that slashes subsidies to education loan providers.

The ugly battle between the two sides has highlighted the importance of being as specific as possible when it comes to material-adverse-change clauses in merger agreements.

No longer will MACs be pegged broadly to competition or industry trends, bankers say.

"I think as a result of ensuing litigation," said Steven Smith, joint global head of leveraged finance at UBS, "that people are going to be very particular about MAC language and be specific about what it means."

(Editing by Lisa Von Ahn)