Clash of the titans to save Sallie Mae LBO

NEW YORK (Reuters) - Some of the biggest players in the U.S. financial system may have to make major concessions to complete the $25 billion buyout of student lender Sallie Mae, but even then, the deal could end up in litigation.

Leveraged buyout star Christopher Flowers led the group of private equity firms and banks that agreed to pay $60 a share for Sallie Mae in April.

But since then, legislation slashing subsidies to student lenders and a serious credit squeeze have jeopardized the transaction.

Sallie Mae's stock has fallen below $49 as the market bets the deal will be renegotiated at a lower price.

The company, officially known as SLM Corp. (SLM.N), had said on July 11 that the buyers believed the legislative proposals on student lender subsidies "could result in a failure of the conditions to the closing of the merger to be satisfied."

Sallie Mae disagreed.

Shareholders have already voted to accept $60 a share, and the student lender's chairman, Albert Lord, is known as an uncompromising figure who fights hard for his investors.

Described by some a "force of nature," Lord needs to see a solution that he can sell to shareholders.

But the buyer group is not without its share of strong personalities, given that it includes two of the biggest U.S. banks -- JPMorgan Chase & Co. (JPM.N) and Bank of America Corp. (BAC.N) -- led respectively by hard-nosed CEOs Jamie Dimon and Kenneth Lewis.

They, too, have to live with any solution. Satisfying four negotiators as tough as Flowers, Lord, Dimon and Lewis will test even the most experienced dealmakers.

"The personalities are big because the companies are big," said John Orrico, portfolio manager at the Arbitrage Fund in New York.

"Flowers doesn't want to walk away," he said. "No one wants to walk away. They saw an opportunity to make a lot of money here -- with the right structure at the right price, though."

Orrico believes the deal can still be done, but not without tough compromises by men who are not used to yielding an inch.

Sallie Mae's board must be "realistic" and accept a lower price, he said, but added: "There is a price at which the board will say that our prospects as a stand-alone company are stronger than selling out at a certain price now."

Sallie Mae and the buyer group, which also includes Friedman Fleischer & Lowe, declined to comment.

HARDBALL

Last week Congress approved legislation that slashes subsidies to student lenders, and President George W. Bush is expected to sign the bill into law.

Meanwhile, among eight closely watched leveraged buyouts monitored by Reuters earlier this week, the roughly 23 percent arbitrage spread on the Sallie Mae deal, the difference between the current and offered price of an acquisition target, was the widest of the bunch.

The wider the spread, the more investors doubt the transaction will close.

The deal has a breakup fee of $900 million, but the buyers would not have to pay it if they could prove that the legislation has a material adverse impact on the transaction.

Further jeopardizing the deal, turmoil in the credit markets has held up financing packages for numerous U.S. leveraged buyouts, leaving a backlog of roughly $330 billion in deal fundings to be completed.

The Sallie Mae deal involves billions of dollars of loan financing.

"We think the legislation is merely an excuse, or a convenient way for Flowers to potentially exit the transaction that is now less attractive -- because it is much harder to finance now," said CreditSights analyst Richard Hoffman.

"We went from a market where you could sell debt like hotcakes to (where) there is no one answering the phone," he said. " ... I think this is J.C. Flowers' way of playing hardball."

Hoffman said he still believed a deal can be thrashed out at a lower price, but added: "I think it's almost a coin toss here in terms of what happens."

It all comes down to the protagonists' willingness to compromise. Some believe the first public moves to revamp the transaction will take place as soon as next week.

"Flowers has been 'mum's the word.'" said Hoffman. "Sallie's personality in these kinds of situations is to take the offensive more so, and they have been doing that."

But from Flowers' perspective, he added, "it's kind of a black eye" to the private equity firm if it walks away.

Dealmakers involved are hoping that the sparring will not end with black eyes all round.