Tuesday, August 21, 2007

I don't know... fly casual

On the eve of Iraq War II: Bush's Revenge, I remember reading about the city council of Berkeley California holding a vote on whether or not we should go to war. I'm sure we could have chalked this up to political grandstanding for the councils mostly liberal constituency, but at the time the whole thing just stuck me as funny. First of all, it was a guarantee that the city council of Berkeley was going to vote against the war. Second, it was a guarantee that the vote would make no difference at all.

That brings us to the matter of not-yet-closed LBOs. Shareholders approved JC Flowers et. al.'s purchase of SLM Corp for $60/share on the 15th. Today, Tribune's shareholders similarly voted for the $34/share buyout offer from Sam Zell. These votes promise to go much like the Berkeley war vote. SLM in particular, whose stock was trading at $47ish before the vote, so there was little doubt shareholders would vote for the $60/share proposal. But whether or not the deal is consummated appears entirely up to the consortium of banks and private equity firms. Since the deal was first struck, two things have happened to significantly change the economics of the SLM deal, as well as other LBOs. First the high-yield market has been obliterated. Second, banks are becoming less willing to extend leverage.

The subsidy cut by Congress may be the excuse used if Flowers and co. try to back out of the deal. But its a hostile bond market that is causing these deals problems.

There is a larger question here. The widening of high-yield spreads impacts all of the LBO deals that have been struck recently but not yet funded. A quick look at the stocks of the sellers shows a widening gap between the announced purchase price and the trading level. Is this telling you some of these deals will wind up being canceled?

Doubtful. Private equity still has a ton of cash. They need to put it to work. Backing out of a deal is clearly not their first choice.

A better option would be to use the potential of cancellation as leverage to lower the purchase price. The sellers would likely be amiable. Take Sallie Mae. It isn't like anyone else is going to offer $60. With the stock trading at $48, shareholders would probably jump on an offer of $54. Recent stories that banks hung with bridge loans might be willing to pay the break up fee only increases private equity's leverage.

TXU is another example. They are telling shareholders that if the LBO isn't completed, they'd likely breakup the company, and they do not believe they'll realize the same value. TPG and KKR might not have a good enough excuse to negotiate the TXU price lower, but TXU's stock (about 8.5% below the deal price) is trading like there is some possibility of a break up or renegotiation.

The Alltel and First Data deals will be interesting to follow as well. Like TXU, either of these companies could be sold off to strategic buyers at a lower price. In each case, shareholders are going to be highly motivated to get a deal done. At this point, ANY deal will suffice.

I don't know anyone who works someplace like KKR or Blackstone. I can imagine that there is a bit more stress there than was the case 6 months ago. The liquidity crunch is increasing the odds that one of these deals doesn't work, and of so they'd better get out out of there pretty quick. But there is no way for private equity to keep their distance without looking like they are keeping their distance. After all, the investors in their funds expect strong returns, which isn't going to happen so long as their money is stuck in cash. I imagine Stephen Schwarzman is walking the halls telling his people "Hey, how about a little optimism?"


DAB said...

This brings up an interesting question. Given how much these firms are levered, do they actually have that much hard cash to put to work? How much of their financing was on a short term float that is now getting eaten up in widening spreads? I think your post reflects the prevailing opinion that they do have a lot of hard cash, but given their opacity the private equity concerns might just be hiding behind their recent success and hoping that the credit market improves in the fall.

The thing about TXU that makes that deal different from most other private equity deals that have ever happened is that the cash flows of a utility are highly predictable. Yes, they are by and large in the so called unregulated market, but wires will always be more (distribution) or less (transmission) regulated. Furthermore, some concept of regulation still exists in the retail price paid by the customer even in the "unregulated" markets like Texas (ERCOT) mopping up some of the retail and a lot of the generation expense.

The private equity concerns hyped up the unregulated component of that deal, but really they wanted it because the debt could be paid by nice, steady, and regulated cash flows...

Accrued Interest said...

I think TXU has an advantage over some others, especially FDC and AT, in that they have better assets. I also agree with the steady cash-flow thing. Enron was a notable exception, but mostly utilities are highly leveraged strong cash flow companies.