I've spilled a lot of virtual ink on the subject of LBO's since this blog began. I'd like to think that this space has been a pretty good source of commentary on LBO's in general as well as several specific deals/rumors from a bond holders perspective. Coverage of private equity activity in the mainstream media is at best, equity oriented. I'd go so far as to say that much of the coverage of private equity activity in the last year been more about vilification and less about economics. One sometimes gets the sense that the average financial journalist sees financial engineering as some sort of shell game. I think this attitude reveals more about the writer than about the subject matter.
Enough soapboxing. Let's talk about my favorite borrower: Alltel. Before we go any further, let me say that I am a holder of Alltel bonds through client portfolios, and I may buy more or sell the position at any time, regardless of the commentary herein. Let me further say that Alltel may be the second most risky A-rated bond in the world (after Sallie Mae, who's days as an A-rated company are very numbered.) Therefore anything I say here should not be considered as advice in regards to Alltel or any other bond. In fact, I'm probably just talking up my position and you should ignore me entirely. I'm channeling Bill Gross here. Plus if you are a retail buyer, you are going to get screwed over by your broker anyway if you try to take a position. So don't bother.
Yesterday, the Wall Street Journal reported some relatively concrete information on potential suitors for Alltel. This after many months of speculation rising and falling about a LBO for Alltel. My attitude toward rumors is this: the more specific the information offered by a respectable media source, the more likely its true. Of course, that doesn't mean Alltel will be bought out, it just means that when the Journal says Blackstone and others are working on a deal, I believe they are indeed working on it.
Now, I'm not a private equity analyst, but here are some difficulties I for see in any deal for Alltel.
- Alltel executives have said they want to keep debt to 7x cash flow. That would mean they could take on about $20 billion in debt in total, according to the Journal. That fits with "Cash Flow" being defined as operating plus investing cash flow. Alltel's current market cap is $22 billion, and they currently have $2.6 billion in long-term debt. So they can add about $17.4 billion in new debt. Let's assume the actually buy out price is $24 billion (~10% premium). That means that the buyer will have to put up $6.4 billion in equity cash.
- Let's say that they want a 20% IRR over 3 years. That's a 73% total return, or about $4.5 billion in dollars. They would have to sell Alltel in 3 years for $28.5 billion.
- What are the odds that Verizon or another strategic buyer would be interested in Alltel in 3 years and $6.5 billion more than today's price given that they are passing at today's price. In other words, if Verizon wants Alltel, they should buy them now. Waiting will certainly cost them more.
- I doubt very seriously that Alltel could do a new IPO at a price higher than today's price. It is widely believed that Alltel cannot survive long-term with their current business model. Other providers have tremendous scale advantages, and eventually, Alltel just won't be able to compete. Alltel has hung on because everyone knew that their customer base was valued by various other telecoms. In essence, there is a takeover premium in this company that does not reflect the basic business fundamentals. If the company goes private now, with all the telecoms passing, and chooses to go public in 3 years rather than sell to a telecom, that takeover premium has to disappear.
- Alltel only has about $7 billion in tangible assets on their balance sheet. In order for them to secure bank financing as a BB-rated credit, they will probably need to secure the debt with assets. But their current debt does not allow new debt to be secured ahead of old debt. That might mean that the private equity buyer also has to foot the bill for a bond tender, further increasing the price of the deal. On the other hand, this might play out much like First Data, as both companies had fairly small debt loads that could be tendered with a relatively small total cost.
I honestly think the most likely scenario would be that Alltel is bought by Verizon or Sprint. Either would be great for bond holders. Its possible that the LBO results in make whole calls, which would also be great for bond holders. Finally, its possible that nothing happens. That would be great for bond holders. By the way, their current spread equivalent to a BB-rated bond anyway. How bad can this get?