I was talking to a friend of mine a few weeks ago in NYC who runs a large endowment that is associated with a legendary wall street investor. Apparently the patriarch of the family, who in my friends tenor there has never showed up to the investment meetings, surprisingly attended the meeting that week to share his thoughts on all the happenings in the market. His comments apparently were that what’s looming may be the worst economic bust he has ever experienced in his long and illustrious career. When you hear that, you stop and take notice!
I caught up with another friend today who works for a bulge bracket investment bank and he explained what’s going on in LBO market in layman’s terms for me:
There are $400B of debt lined up for pending acquisitions by PE firms. The debt was underwritten by investment banks, i.e. they pledged to put the money in place from their balance sheets - with all the poor covenants in all - assuming that they are going to be able to syndicate the debt post transaction.They can not!
Currently, deal by deal they are repricing the $400B. The first to go part of a $24B raise, was a $5B piece (I think Equity Office). It got priced at $0.96 on the $1.The overall consensus is that at $0.90 on the $1 will clear all the backlog. At that price, collectively all the banks that underwrote the $400B would loose $40B this year!
There are some think that it would even go lower which may put a number of banks with smaller balance sheets at risk of going under. Most LBO’d companies like Equity Office are blue chip companies, so banks in theory can keep the debt and be OK. But then they may not have the balance sheet to sustain the rest of their businesses, like trading for example.
In the mean time PE firms are laughing all the way to the bank (ironically), because they now control very large companies that are leveraged to the gills. They may have paid a bit too much but their exposure is limited to the equity they have put in place. Some of them are starting to buy the debt of their own transactions on the cheap! Bain, apparently, raised a $6B special situations fund in a few weeks time, so did Appollo and a few others to take advantage of this “special situation”.
My friend thinks the days of $10B+ LBO transactions are over for a long time, it is back to mid market buyouts for everyone.
The silver lining to all this is the IPO market, which is still wide open. I assume, all that money that got pulled out of the debt markets because of the credit crunch has to now go somewhere else and the IPO market is seemingly one of the beneficiaries. As a result there is good liquidity for venture backed companies that weathered the big storm and the subsequent draught and still managed to survive and flourish.
A venture investor that I immensly respect used to repeadetly tell me that we as investors - like every other business - need inventory. If we help build good companies that get to sustain themselves, the good times will come (i.e. the IPO market) and we’d get lot’s of exits, which is exactly what’s happening. All you need to do is be there with inventory to sell when the time is right.
The US economy looks pretty resilliant in light of everything that has happened but it’s starting to show signs of wear and tear. All that could go wrong actually did go wrong! It stareted with the mid term elections, Greenspan is gone, oil prices are at an all time high. We are in the midst of an endless war, budget deficit is worse than ever and consumer confidence is droppping precipitiously. The dollar is at all time low against the Euro and on and on. And, oh by the way, the LBO credit crunch is paled in comparison by the sub prime debt thing.
Yet the US econony is still able to borrow money to finance its deficit. China in particular and the rest of the world still continue to finance us by buying and holding US treasury bonds. I am optimistic yet I can’t seem to shake off the gloom and doom prediction.
