Don´t Call It A Bubble........

After the introduction of the "Pay-If-You-Can-Loans" the comeback of Toggle/PIK Bonds are more than early warning signs that something is at least a little bit "frothy"...... The same is true for numerous stock markets ( see the following chart Mexican Stock Market Back To All Time Highs WOW!)

Nachdem ja vor kurzem die "Pay-If-You-Can-Loans" ins Leben gerufen worden sind ist die noch vor wenigen Monaten undenkbare Wiederaufersteheung der Toggle/PIK Bonds ein weiteres Anzeichen, das nennen wir es mal vorsichtig, eine leichte "Überhitzung" eingetreten ist.... Leider sieht es in etlichen Aktienmärkten nicht bedeutend anders aus ( siehe nachfolgden Chart Mexican Stock Market Back To All Time Highs WOW! )

Treasurers Embrace Pay-in-Kind Bonds as Ghost of Lehman Fading
( Bloomberg ) Companies are selling debt with terms last seen before credit markets froze, showing why the world’s biggest bond fund manager says another bubble may be brewing.

JohnsonDiversey Holdings Inc., a Sturtevant, Wisconsin, maker of cleaning supplies, and Wind Acquisition Holdings Finance SpA, parent of Italy’s third-largest mobile-phone company, sold bonds that can pay interest in new debt instead of cash, the first such deals since 2007, according to Bloomberg data.

Goodman Global Inc. raised $320 million to pay its owner, leveraged buyout firm Hellman & Friedman, a dividend, one of at least seven similar offerings since November

Two years after credit markets seized up, treasurers are luring investors to junk bonds that returned a record 58 percent last year, as measured by Bank of America Merrill Lynch indexes. U.S. sales of $162 billion beat the all-time high of $149 billion in 2006, Bloomberg data show.

“Six months ago I wouldn’t have imagined being able to do this deal,” said Karim-Michel Nasr, head of corporate development in Paris at Weather Investments SpA, Wind’s holding company.....

Capital Access

At least two dozen borrowers since November have asked lenders to change terms of debt agreements to permit bond sales, extend loan maturities or pay dividends to their owners, Bloomberg data show.

Access to capital means defaults will likely drop to 3.9 percent by November from 12.7 percent a year earlier, New York-based Moody’s Investors Service says.

Speculation that companies will have less difficulty making payments has led investors to accept lower interest rates and looser borrowing terms. The extra yield demanded on junk bonds instead of Treasuries narrowed to 6.39 percentage points at the end of 2009 from almost 19 percentage points on March 9, Merrill Lynch indexes show. Speculative grade debt is rated below Baa3 by Moody’s and BBB- by Standard & Poor’s.

‘We Forget’

“I’m looking at some of the things that are being priced and I’m saying, ‘Wow, how quickly we forget,’” said JohnsonDiversey Chief Financial Officer Joseph Smorada. The market is “starting to get a little dangerously aggressive,” he said.

The company sold $250 million of so-called toggle debt due in May 2020 on Nov. 20 that allows it to pay a 10.5 percent interest rate either in cash or notes for the first five years.

The first pay-in-kind bonds since 2007 were part of a $2.6 billion recapitalization in which New York-based LBO firm Clayton Dubilier & Rice Inc. agreed to buy a 46 percent equity interest in the company.

Moody’s gave the notes its fifth-lowest ranking of Caa1, saying the debt is five times more than adjusted earnings before interest, taxes and amortization costs. It has had negative free cash flow the past three years, though it’s expected to break even in 2010, Moody’s said.

‘Dangerously Aggressive’

“In early 2009, I don’t think we could have borrowed a nickel if our life depended on it,” Smorada said. Investors submitted bids for almost four times the amount of notes offered, he said.

Investors haven’t lost discipline and companies are mainly selling bonds to refinance or cut interest expenses, said William Cunningham, the head of credit strategy and fixed-income research at State Street Corp.’s investment unit in Boston.

Wind Acquisition of Luxembourg raised $1.1 billion last month selling 7.5-year, 12.25 percent notes in dollars and euros that allow it to pay interest with more debt until 2014. Wind, controlled by Egyptian billionaire Naguib Sawiris and the parent of Wind Telecomunicazioni SpA, boosted the offering 50 percent as demand rose.

The investment flood has undercut efforts to toughen restrictions that protect investors, said Alexander Dill, senior covenant officer at Moody’s in New York. Many covenants are “largely replicating” rules from 2006 and 2007, Dill said in a Dec. 10 report.

TRW Automotive Inc., the world’s biggest supplier of vehicle-safety equipment, sold $250 million of eight-year notes in November rated Caa1 with covenants “substantially unchanged” from its 2007 indenture for debt graded four steps higher at Ba3, according to the Moody’s report. The Livonia, Michigan-based company said Dec. 22 it raised $400 million in term loans as lenders amended and extended its revolving credit facility.

FT Alphaville

Global high yield debt volume for the week of January 11th totaled $11.7 billion, the biggest week for high yield debt on record. The previous record was set during the week of November 5, 2006 when $11.4 billion was raised. With $14.4 billion raised so far this month, it is the best all-time start for the high yield markets since records began in 1980.

Update High Yield Bonds Continue To Do Well Bespoke

Over the past month or so, the only area of the bond market that has done well is junk. Both Treasuries and investment grade corporates have struggled, while high yield bonds have continued to surge. Below we highlight a six-month performance chart of the high yield bond ETF (HYG) and the investment grade corporate bond ETF (LQD).

Mortgage-Bond Leverage Reaches 10-to-1

Wall Street firms are loosening terms of their lending to mortgage-bond investors as markets heal, an RBS Securities Inc. executive said.

Repurchase agreement, or repo, lending against the debt has expanded so much since freezing in late 2008 that some banks now offer as much as 10-to-1 leverage and terms as long as one year on certain securities backed by prime jumbo-home loans

Update

Bubble warning ( Economist )

Once again, cheap money is driving up asset prices ( Economist )

Ladies and Gentlemen, We Are Trading On The Moon :-) Reformed Broker

"Pay-If-You-Can-Loans"

At least they have to pay the interest in cash and not aluminium.....;-) Even when this is in part an Kreml lead attempt to save the oligarchs but the"Pay-If-You-Can-Loans" are close to kick theToggle/PIK Bonds from the top spot of "innovations".... ;-) Michael Panzner with his comment "return of irrational exuberance in the credit markets" is spot on. ZH with this summary The High Yield Market Has Officially Topped, With Bondholders Eager To Cash Out Existing Equityholders In The Crappiest Of Names & Distressed debt on the wane in US markets confirms the view that memories are short............

Immerhin müssen wohl noch die Zinsen gezahlt werden......Selbst wenn ein Teil dieser Praxis dem Kreml indirekt dazu dient die Oligarchen zu retten schafft es die Art der Kreditvergabe bzw. Restrukturierungen doch fast inzwischen legendären Toggle/PIK Bonds vom Spitzenplatz der Innovationen zu vertreiben... ;-) Denke das Michael Panzner mit seiner Bemerkung"return of irrational exuberance in the credit markets" der Wirklichkeit ziemlich nahe kommt..... ZH mit einer Auflistung an "Absurditäten" aus dem Kreditbereich ( sieheThe High Yield Market Has Officially Topped, With Bondholders Eager To Cash Out Existing Equityholders In The Crappiest Of Names & Distressed debt on the wane in US markets) bestätigt die Ansicht das hier etwas erheblich aus dem Ruder gelaufen zu sein scheint.....


Bankers Say Deal Is Near to Restructure Rusal’s Debt NYT

Rusal, the world’s largest aluminum producer, which is struggling under $17 billion in debt, is close to an agreement with about 70 banks to restructure its loans on terms considered favorable to the company and its billionaire owner, bankers said on Wednesday

The banks will allow Rusal to operate essentially under a pay-as-you-can agreement, though pegged to aluminum prices, according to terms made public this year. The company will be permitted to roll missed payments into the capital and begin repaying principal only when the global economy recovers, and with it prices for aluminum.

Rusal signs comprehensive debt restructuring deal MW

Russian aluminum giant Rusal said Thursday it has signed a deal on the comprehensive restructuring of its debt of $16.8 billion. The restructuring of $7.4 billion debt to international lenders will be split into two phases, the company said. During the initial four-year period, principal repayments will be made on a "pay-if-you-can" basis predicated on the performance of the business, while the second phase will involve the refinancing of the remaining debt by current lenders for an additional three years.

Rusal has also signed agreements on the restructuring of $2.1 billion of debt with its Russian lenders. It has also agreed with Onexim, a Russian investment fund, to restructure $2.7 billion in debt and to convert $1.82 billion of debt into a 6% shareholding in Rusal. The remaining $880 million of debt will be restructured on the same terms as applicable to the international lenders, with the accumulated interest thereon to be paid in cash.

Rusal's CEO Oleg Deripaska said Rusal "is ready to focus on implementing its new strategic objectives." There has been media speculation in recent weeks that Rusal is preparing for an initial public offering in Hong Kong, though the company hasn't confirmed these reports ( Deripaska plays down Rusal delay > no quick "pump & dump"....)

Rusal Gains Approval for Hong Kong Listing WSJ

But the green light was given on the condition that it won't sell the deal to retail investors, in a bid to "protect" Hong Kong's retail investors from the complexities of the deal ( No "pump & dump" )

I urge everybody to read page 6 from the following High Hendry report about the outlook of the aluminium market ( after he met with management of Norsk Hydro ).....I´m pretty sure the banks have "calculated" this "rosy" outlook in their "pay-if-you-can" repayment shedule..... The clip Prime Minister Putin Bitch Slaps Oleg Deripaska also taken from the report is "hillarious"!

I empfehle allen die Seite 6 des folgenden Reports von Hugh Hendry zu lesen. Der hatte ein eingehendes Gespräch mit Norsk Hydrdo zum Zustand der Aluminiumindustrie......Bin mir sicher das die Banken diesen "überragenden" Ausblick gewohnt konservativ in Ihre "pay-If-You-Can" Kreditkalkulationen mit einberechnet haben.....Aus dem Report auch der Clip Prime Minister Putin Bitch Slaps Oleg Deripaska den man gesehen haben sollte..... ;-)

Hugh Hendry Eclectica Nov09

More Green Shoots...... US Corporate Default Rate Edition

Green Shoots as far as the eye can see......... The "Green Shoots" or "Second Derivitive" nonsense will vanish as fast as the other buzz words like "Contained" , "Decoupling", "Cash On The Sidelines" , "Stock Are Cheap" etc......

Noch mehr Futter für all diejenigen die in jeder veröffentlichten Zahl momentan Green Shoots erkennen ..... Just kidding...... Bin mir sicher das die Bezeichnungen "Green Shoots" oder "Second Derivative" sich nahtlos in die Reihe der letzten Modebezeichnungen ( "Contained", Decoupling", "Cash On The Sidelines" usw ) einreihen werden. Warum wundert es mich eigentlich nicht das alle permanent suggerieren das das nun der Zeitpunkt gekommen ist einzusteigen.....

Thanks to Telegraph

FT Alphaville S&P said on Monday the US corporate default rate had hit a seven-year high:

Corporate defaults continue to rise rapidly in 2009, nearly matching the number in all of 2008. Through May 13, 2009, 121 issuers defaulted, affecting debt worth $297.22 billion. By comparison, 126 defaults were recorded in all of 2008, affecting debt worth $433 billion. Of the 121 defaults in 2009, 85 are from the U.S., 21 are from emerging markets, seven are from Europe, six are from Canada, and one each is from Australia and Japan.

Nice to see that markets are allowed to work in at least some parts of the market........Now add the following chart & read examples like this ( see Another Private Equity Deal That Went Bust Within 24 Months ) and you get even more green shoots.... Sarcasm off......

Immerhin schön zu sehen das dem Markt zumindest in einigen ausgewählten Teilen der Wirtschaft erlaubt wird zu arbeiten....... Der nachfolgende Chart kombiniert mit Beispielen wie diesem lassen erahnen das hier in der nächsten Zeit noch die ein oder andere nette Überraschung auf uns wartet.......

Number Of The Day " Percentage Of US Companies With A Junk Rating"

About 50% of U.S. companies have below-investment-grade credit ratings

Another Private Equity Deal That Went Bust Within 24 Months

Commercial Real Estate (CRE) & Private Equity...... When ever you hear this combination during the next few years it will be almost to 100 percent in connection with disastrous deals...... No surprise that Blackstone & Fortress are involved once again....... :-) The enitire CRE complex will be the next very very big headache for the balance sheets from banks...... It´s a safe bet that we will hear similar stories also from the LBO front on a regularly basis ( see Tribune Co. Could Be Flirting With Bankruptcy NYT) ......

Wann immer in den nächsten Monaten die Begriffe Commercial Real Estate & Private Equity im Zusammenhang auftauchen kann man sicher sein das es sich fast zu 100% um das implodieren von Mrdschweren Deals handelt...... Sicher auch kein Zufall das die Namen Blackstone und Fortress in schöner Regelmäßigkeit auftauchen..... Der gesamte Bereich der gewerblichen Immobilien wird noch für extrem große Kopfschmerzen bei den Bänkern und entsprechend große Löcher in den Bilanzen der Banken sorgen...... Wir werden uns an ähnliche Schlagzeilen vor allem auch im Zusammenhang mit den berühmt berüchtigen LBO´s von "Pirate " Equity sowie fremdfinanzierten Übernahmen im allgemeinen ( z.B. CONTI/SCHAEFFER..... ) gewöhnen müssen..... UPDATE: Erster großer Autozulieferer meldet Insolvenz an Manager Magazin

WSJ Extended Stay Could Transfer Chain to Lenders
Extended Stay Hotels Inc. is in early talks that could result in turning the hotel chain over to its lenders, a sign of the deep trouble awaiting the commercial real-estate business.

Extended Stay's difficulties signal a new phase of distress in commercial real estate, because they arise directly from the weakening economy. Until now, problems have mostly involved developers unable to obtain refinancing for otherwise healthy operations.

Lightstone Group LLC, Lakewood, N.J., bought Extended Stay from Blackstone Group LP for $8 billion in April 2007. The deal was highly leveraged, hastening Extended Stay's troubles. The chain has no major debt expirations due soon

But Extended Stay's cash flow is crashing, as business activity across the country contracts. That is putting fewer people in its 684 U.S. and Canadian hotels, used by corporate travelers on long assignments. Extended Stay has 13,000 employees. It is too soon to say if a takeover by lenders would result in layoffs or hotel closings, according to people familiar with the matter.

As conditions deteriorate, Extended Stay has been forced into discussions with its lenders, and people involved in the talks say a transfer of ownership could come within a month or two. Extended Stay has recently hired Lazard Ltd. as financial adviser and New York law firm Weil Gotshal & Manges as bankruptcy counsel......

During the real-estate lending boom, Wall Street originated $600 billion of commercial mortgage-backed securities. The default rate on commercial mortgage debt has remained near historic lows, even while residential-related debt suffered a severe downturn.

But that is now beginning to change, sending new shock waves into much-battered banks, private-equity funds and other financial institutions that participate in the $1 trillion commercial real-estate debt market. Hotel landlords typically are the first to feel the pain in a downturn because hotels have the shortest leases in real estate -- one night at a time.

bigger/größer Thanks to Calculated Risk

> I just cannot wait for this deal Hilton's $20 Billion Sale to Blackstone Is Completed to blow up........

> Ich denke es wird nicht mehr lange dauern und der absolute Königsdeal unter den Hotelbuyouts ( Hilton's $20 Billion Sale to Blackstone Is Completed ) dürfte in ähnliches Fahrwasser geraten.....

( OKTOBER 2007 ) The sale, for $26 billion including debt, is a record for the hotel industry. New York-based Blackstone, which already owns the La Quinta lodging chain, joins Apollo Management LP and TPG Inc. in targeting hotel companies for their cash flow and real estate.

An Extended Stay failure reveals how a commercial real-estate downturn could ripple through the financial system.

When Lightstone Group and preferred equity partner Arbor Realty Trust bought Extended Stay from private-equity firm Blackstone Group in 2007, it borrowed more than $7.4 billion. Wachovia Corp., Bank of America Corp., Merrill Lynch & Co. and Fortress Investment Group put in $3.1 billion in so-called mezzanine financing, which isn't as highly secured as other types of debt. People involved in the transaction say an analysis of the company's value shows that much or all of the mezzanine debt could be wiped out in any renegotiated deal.

Bondholders have hired Houlihan Lokey Howard & Zukin for restructuring talks.

Extended Stay is still meeting its debt service, but people familiar with the matter say it could default within the next 60 days if the economic downturn continues as expected. Revenue per available room, or RevPar, a common hotel-industry measure, will be down more than 10% this year at Extended Stay, according to someone familiar with the matter. Much of that decline has come in the last two months.

But it was the Extended Stay deal that was Mr. Lichtenstein's biggest. Extended Stay has operations in 44 states and Canada. It was also among his riskiest deals, as

Lightstone, with help from Arbor Realty, arranged to put down just $600 million of equity, or 8% of the total price. (Blackstone, which made about $3 billion on the sale, kept an equity interest.)

Mr. Lichtenstein saw increasing demand from business travelers who needed hotel accommodations for weeks or even months at a time. He also believed he could unlock value at Extended Stay by taking advantage of the chain's size and paying more attention to management.

A couple of months after the deal closed, Mr. Lichtenstein acknowledged the easy money that helped him complete the deal had disappeared. "We were one of the last deals in," he said.

Troubles also have surfaced at Lightstone's Prime Retail division, which owns roughly 30 malls and shopping centers in the U.S. and Puerto Rico. Lightstone has sought to turn over at least six of its malls to lenders after falling behind on debt payments.

UPDATE via NYT:

Similar screenplays/attributes can be attached to almost every other deal from "pirate" equity since 2005....

Ähnlichen Drehbüchern dürften fast alle Übernahmen von "Pirate" Equity seit 2005 früher oder soäter folgen......

In a report by the ratings agency Standard & Poor’s, 86 companies weren’t meeting their debt obligations through mid-November of this year, with 53 of those, or 62 percent, having ties to private-equity firms at one point in their lives.

Number Of The Day " Percentage Of US Companies With A Junk Rating"

This at the start of a deep and long recession...... After the events of the last 3 month it is valid to wonder how much of this debt will get bailed out ( GM....) or will end up without much disclosure on the Fed´s balance sheet......I wonder how many companies are now on the brink of bankruptcy just because they decided to make big debt financed stock buybacks or megalomaniac takeovers & buyouts......

Diese Zahl bereits am Anfang einer schweren und langwierigen Rezession bedeutet nichts Gutes..... Nach den Ereignissen der letzten 3 Monate darf man wohl berechtigt fragen wieviel von diesem Junk entweder ein Bailout ( GM.... ) bekommen wird oder gar ohne großartige Transparenz in der immer weiter explosionsartig wachsenden Fed Bilanz verschwinden wird..... Tragischerweise befinden sich etliche dieser Unternehmen nur dank massiver schuldenfinanzierter Aktienrückkaufprogramme und größenwahnsinniger schuldenfinanzierter Übernahmen ( denke vor allem an Private Equity aber leider auch an den Fall Siemens VDO, Conti, Schaeffler ) in dieser wohl letzlich "tödlichen" Situation.......


WSJ Junk-Bond Market Has Closed the Door
Yields Upward of 20% Make It Too Pricey for Borrowers; Zero Deals Made It in November

About 50% of U.S. companies have below-investment-grade credit ratings, making the $750 billion junk-bond market a vital source of financing for car makers, airlines, retailers, utilities, restaurant chains and media companies

>The next chart is making things even scarier........ Within the "junk" label the remaining "quality" has deterioting fast and furious especially over the past few years..........

> Der nächste Chart macht alles nur noch erschreckender...... Innerhalb des "Junkuniversums" hat sich zudem die Qulität besonders im Laufe der letzten jahre massiv verschlechtert......

First Data Loans Delayed as KKR, Banks Keep Talking, People Say

It looks like the banks and investors have realised that they have gone too far. We can now take this cover "The trouble with private equity" and the men one step further...... Please click at the label to read more about the private equity mess.

Es sieht ganz so aus als wenn Banken und Investoren endlich realisiert haben das Sie heftigst überzogen haben. Ich denken wie können das Cover von "The trouble with private equity" erweitern und davon ausgehen das er sich jetzt auf dem "Abstieg" befindet.... Wenn Ihr mehr "schmutzige" Details zum Thema Private Equity lesen mächtet klickt bitte auf die Labels am Ende des Posts.

Sept. 12 (Bloomberg) -- Kohlberg Kravis Roberts & Co. may delay the sale of loans to fund its $26 billion buyout of First Data Corp. until at least next week after failing to agree on terms with its bankers, people with knowledge of the talks said.

KKR, the New York-based private-equity firm run by Henry Kravis, and banks led by Credit Suisse Group couldn't agree today on pricing or how much of the debt lenders will try to sell, said the people, who asked not to be identified because the negotiations are private.

As recently as April, buyout legend Henry Kravis proclaimed a "golden age" of private equity

The First Data sale is the biggest to be attempted since rising U.S. mortgage defaults triggered the highest leveraged buyout borrowing costs in four years. It's being watched by bankers and buyout firms as a gauge for how $320 billion in debt committed for pending LBOs may fare. The banks would have to hold the loans and bonds if they can't be sold to investors.

``The pricing environment in the credit markets reflects illiquidity and fear,'' said Peter Plaut, an analyst with Sanno Point Capital Management LLC, a New York-based hedge-fund manager. ``If First Data gets done, it will show a significant vote of confidence.''

KKR has other deals to finance after Greenwood Village, Colorado-based First Data, the largest processor of credit-card payments. The firm and TPG Inc. agreed in February to buy Dallas-based power producer TXU for $32 billion in the largest U.S. buyout. The acquisition, which has been approved by shareholders and regulators, is set to close by the end of December.

> If you read the details from the TXU deal it is no wonder that the banks are having trouble to unload this junk.

> Wenn man sich die Details des TXU Deals durchliest ist es nicht weiter verwunderlich das keiner diese waghalsigen Kredite aufnehmen möchte.

Investors Balk
Demand for LBO debt has evaporated. After buying a record $754 billion of leveraged loans this year, investors are balking at debt without covenants, or restrictions, that give them greater power over a company's finances. More than 50 deals have been abandoned or reworked.

KKR has yet to agree to terms that would give its banks confidence they can sell the loans to investors without making the acquisition potentially less profitable, the people said.

The two sides have discussed various structures, including adding a provision that dictates how much debt First Data can assume relative to earnings, people with knowledge of the negotiations said Sept. 10.

Marketwatch reports First Data LBO may be costly for banks involved
Even if the banks manage to sell all the loans, they will probably have to offer them at a discount to entice investors.

If the First Data loans are sold at 94 cents on the dollar, that would leave the banks with a loss of between three and four cents on the dollar. On a $14 billion loan deal, that translates to a loss of $420 million to $560 million.

Citigroup is particularly exposed to such problems, according to analysts.

Quote Prince CEO Citigroup just a few weeks ago The $1 Billion Break Up Fee & An Ignorant And Deaf CEO

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing".

The bank is a lead underwriter on five of the six largest leveraged loan pending, including debt to support the LBOs of BCE Inc. , TXU Corp. and Alltel Corp. according to Banc of America Securities. That's more than $70 billion worth of loans

> But they are not alone.....See this excellent table The Banks Behind The Biggest Buyouts

> Immerhin sind Sie nicht alleine...Hier eine erstklassige Übersicht The Banks Behind The Biggest Buyouts

Citigroup is also lead underwriter on three of the five largest pending high-yield bond deals, worth more than $20 billion, Banc of America Securities noted.

First Data is one of the last so-called covenant-lite deals. These types of loans, which give companies more leeway and creditors less power, have fallen out of favor in recent months.

Over the weekend, KKR agreed to add one covenant to the First Data debt, the Wall Street Journal reported on Tuesday. The company must now maintain a certain ratio of earnings, before interest, depreciation, tax and amortization (EBITDA) to senior debt, the newspaper explained.

However, that's not much of a concession, especially considering the LBO is already highly leveraged, KDP's Lee said.

This is just in from the FT Talks to start on TXU $45bn financing
Negotiations over the terms of the financing package for the $45bn buy-out of TXU, the Texas-based energy group, are set to begin after the purchase by US private equity groups KKR and TPG received final regulatory approval earlier than expected.

The banks funding the TXU takeover - Citigroup, Goldman Sachs, JPMorgan, Lehman Brothers and Morgan Stanley - are expected to push for the inclusion of covenants in $37bn of loan financing and higher interest payments to make the debt more palatable to investors. But the buy-out groups will be reluctant to make any concessions that could hurt returns. The bond portion, worth about $8bn, would be sold after the loans.

Further Details Home Depot Private Equity Deal

Business Week has a cover story Private Equity's White-Knuckle Deal about private equity in general and the Home Depot deal in special. I have filtered some of the Home Depot details but i suggest to read the entire story. This is some kind of follow up to the post Home Depot Hit As Credit Crunch Squeezes Deals

After hearing more of the details it wouldn´t surprise me if this deals will haunt Home Depot ......

Business Week hat eine Titelgeschichte zum Thema Private Equity Private Equity's White-Knuckle Deal und konzentriert sich hierbei besonders auf den modifizierten Deal von Home Depot. Der komplette Bericht ist lesenwert. Das gabze hier ist ne Art Vervollständigung zu meinem Post Home Depot Hit As Credit Crunch Squeezes Deals

Nachdem die letzten Details an Licht gekommen sind bin ich mir ziemlich sicher das dieser Deal und die Zusagen Home Depot noch jahrelang verfolgen und einholen wird.

After bashing the media almost every week i think it is appropriate to praise Business Week for warning about the risks associated with private equity in their cover story from October 2006 Gluttons At The Gate "A story of excess"

Nachdem ich ja beinahe wöchentlich auf die Medien für Ihre unterirdische Berichterstattung losgehe möchte ich diese Gelegenheit nutzen um ein ausdrückliches Lob an Business Week für Ihre Cover Story vom Oktober 2006 Gluttons At The Gate "A story of excess" die sich mit den Risiken von Private Equity auseinandersetzen.

After several more hours of furious bargaining, an accord was reached. The banks agreed to provide financing, including a reduced loan of $1 billion. Home Depot agreed to assume the loan payments if the firms were to default on it. And the buyout firms agreed to put more cash into the deal, pay the banks higher fees, and give Home Depot a 12.5% equity stake in HD Supply. The final price tag came to $8.5 billion.

The debt terms were revealing. BusinessWeek has learned that the package includes two loose types of funding that have flourished in recent years—exactly the kinds of loans and bonds that pundits had assumed were dead. The $1 billion loan was of a type called "covenant-lite," named for its easy repayment terms. And the deal included $1.3 billion in "payment-in-kind" (toggle)bonds, which allow the borrowers to pay off the debt with securities instead of cash.

Number Of The Day..... Toggle Bonds

Bonds that allow companies to pay interest in extra securities instead of cash, including toggle notes, accounted for almost 9 percent of high-yield debt sold this year, compared with less than 1 percent three
years ago

A retreat from loans with easy terms could put a damper on private equity dealmaking. Covenant-lite loans burst on the scene a few years ago and quickly gained favor among buyout firms looking for easy money. Traditional loans carry strict requirements that dictate when the borrowers have to repay them. Some stipulate that the borrower's profitability must improve every year; if it doesn't, the lender has the right to renegotiate the loan at a higher interest rate or demand repayment immediately. Covenant-lite loans, by contrast, come with relatively few stipulations. Payment-in-kind bonds are just as loose, allowing borrowers to pay off the debt by issuing more securities. Such freewheeling terms are advantageous for borrowers but risky for the people holding the debt.

Investors threw caution to the winds until the credit crunch began, and the market for risky securities vanished overnight. The $8.3 billion in covenant-lite loans made in June shriveled to zero in August, according to Standard & Poor's Leveraged Commentary & Data (MHP ).

Number Of The Day.....Covenant Lite Loans

In 2004, there were just $100 million of such loans. But the total rose to $2.4 billion in 2005, $23.6 billion last year and $103.9 billion in the first half of this year.

He also agreed that Home Depot would guarantee a $2 billion covenant-lite loan for the buyers. The lower deal price certainly appealed to the buyout firms. The discussions were "all remarkably free of acrimony," says someone close to the deal.

Private equity firms have already embraced debt to a seemingly dangerous degree. On average they're paying 14.7 times the target companies' operating earnings, up from 3.8 in 2002, estimates Thomson Financial

> And this at times when earnings are at peak margins and not so depressed like in 2002 and a US recession in the cards..... Get ready to hire the distressed debt manager and float some funds in this segement....I´m just daydreaming how it will be if the distressed fund from Blackstone wants to buy some of the the Blackstone assets that are in trouble......

> Und das zu Zeiten wenn die Gewinnmargen bereits historicche Hochs erreichen und es nicht wie in 2002 noch gewaltige STeigerungsmöglichkeiten gibt. Dazu kommt noch das die US Wirtschaft fast zu 100% in die Rezession abgleiten wird bzw schon geglitten ist. ..... Höchste Zeit Manager die sich in notleidenden Krediten auskennen anzuheueren und neue Fonds für diese Kategorie aufzulegen..... Stelle mir gerade vor wie es wäre wenn der Fonds für notleidende Kredite von z.B. Blackstone Vermögenswerte von einem Blackstone Buyout Fonds kaufen möchte.....

Number Of The Day.... Junk Bond Sales

And i bet the three in August had to made substantial concessions like Home Depot to unload the debt.... :-)

Und ich gehe jede Wette ein das die 3 glücklichen im August erhebliche Zugeständnisse wie im Fall Home Depot gemacht haben.... :-)

Eleven junk-rated borrowers have sold bonds since the beginning of July, compared with an average of 41 a month in the first half of the year, Bloomberg data show. Three found buyers in August.

Not So Smart "In an era of easy money, the pros forgot that the party can't last forever "

What a difference 6 month made..... It was in early February when Business Week ran this cover story It's A Low, Low, Low, Low-Rate World .

Looks like the "Cover Story Indicator" has worked once more.....

Was doch 6 Monate für einen Unterschied ausmachen.....Anfang Februar hat Business Week noch die folgende Titelgeschichte It's A Low, Low, Low, Low-Rate World gebracht.

Es sieht so aus als wenn der "Cover Story Indicator" mal wieder ganze Arbeit geleistet hat.
Not So Smart / In an era of easy money, the pros forgot that the party can't last forever

The boasting and bluster that marked the just-ended era of easy money varied depending on the speaker and his stake in the boom. But the underlying message was consistent: This time it's different. When it came to the hazards associated with borrowing, the old rules no longer applied.

The titans of home loans announced they had perfected software that could spit out interest rates and fee structures for even the least reliable of borrowers. The algorithms, they claimed, couldn't fail. With similar bravado, buyout firms bid up private equity deals, arguing that investors had an insatiable appetite for the increasingly risky and mammoth loans used to fund them. "I don't think it's a bubble," David M. Rubenstein of Carlyle Group told the Financial Times in an interview last December. "I think really what's happening now is that people are beginning to use a different investment technique, and this investment technique, private equity, adds real value."

> This chart from Bespoke shows how well timed the "Low, Low......Rate World" cover was.....

> Dieser Chart von Bespoke zeigt wie gut die Titelgeschichte "Low, Low, ..Rate World" abgepaßt war.

Hedge funds were all too happy to enable the leverage arms race. They, too, borrowed to the max so they could gorge on the debt that financed the housing and buyout booms. "The consumer has to be an idiot to take on those loans," John Devaney, chief executive of United Capital Asset Management, said in May, referring to dicey adjustable-rate mortgages. But since there were plenty of "idiots" out there, and legions of lenders eager to serve them, Devaney and other hedge fund managers eagerly devoured the securities confected by investment banks from batches of dubious home loans. This securitization, the argument went, would spread the risk far beyond banks and mortgage companies. In March, Devaney bragged that mortgage-backed securities were one of his "best-performing investments.

"It didn't work out that way. In June, Devaney's Horizon funds booked a loss of more than 30%, according to Hedge Fund Alert. Shortly after, United Capital suspended redemption requests by investors trying to pull out. Devaney did not return calls for comment.

> maybe he is the guy on the cover.......:-)

> ist wahrscheinlich der Typ auf dem Cover :-)

Making sense of this mess is daunting. One good place to start: the ways various financial players indulged in layer upon layer of leverage, much of it far from transparent. Mortgage lenders threw out common sense underwriting standards. Wall Street sliced and diced the loans, creating the illusion that risk somehow disappeared in the process. Hedge funds then multiplied the leverage by borrowing copiously to buy securities based on the rearranged mortgages. In their version of the game, private equity firms used loads of debt to launch unprecedented buyouts.

bigger / größer

> Looks "contained"´to me....

> Sieht für mich ziemlich "contained" aus......

What some of the smartest guys in each of these fields seemed to forget is that new paradigms can crumble suddenly. Many miscalculated how long the period of easy credit would persist.

Mortgage companies argued their algorithms provided near-perfect precision. "We have a wealth of information we didn't have before," Joe Anderson, then a senior Countrywide executive, said in a 2005 interview with BusinessWeek. "We understand the data and can price that risk."

PRIVATE EQUITY: `A GOLDEN AGE'
As recently as April, buyout legend Henry Kravis proclaimed a "golden age" of private equity. Perhaps he should have called it a golden age of CLOs—collataralized loan obligations.

Like mortgage lenders, the giants of private equity have relied on complicated investment pools to fund their binge. CLOs are cousins of collateralized debt obligations. Managers of the investment pools buy groups of risky, junk-rated loans from banks that have financed buyouts by Kravis and his competitors. The CLOs package the loans, then divide them into risk levels. While the individual loans carry low credit ratings, three-fourths of the securities marketed by CLOs magically boast AAA marks. (That's because some investors give up extra yield in exchange for better protection against losses.)

The financial alchemy has allowed private equity firms to attract a whole new base of investors, including pension funds and insurance companies that never would have bought those risky loans outright. U.S. CLOs raised $100 billion in 2006, quadruple the amount two years earlier.

Buyout firms have generally fronted 30% of the equity in recent deals, vs. just 15% two decades ago. But that doesn't mean firms have been more cautious. Steeled by the seemingly insatiable demand for CLOs, they became bolder and bolder in the deals they pursued. After Kohlberg Kravis Roberts & Co. and Texas Pacific Group's $44 billion bid for Texas energy giantTXU in February, analysts began putting odds on imagined future megabillion-dollar targets like Home Depot Inc. (HD )

As private equity firms bid up the prices for ever-larger LBOs, the transactions began getting riskier. A key measure of leverage, a company's total debt divided by operating earnings, skyrocketed from 4.7 in 2004 to 7.0 in the second quarter of 2007, according to Standard & Poor's (MHP ) LCD. Meanwhile, the ability of companies to cover the interest payments of that debt dropped sharply; the ratio of profits to interest fell from 3.4 to 1.8 in that period.

> It is getting worse if you consider that profit margins are close to record highs and the economy is now tanking.... So there is almost no room for error.....

> Das ganze wird noch dramtischer wenn man berücksichtigt das die Firmen momentan noch Gewinnmargen nahe der historischen Hochs haben und die Wirtscahft sich gleichzeitig abschwächt bzw. wie in den USA sogar abschmiert.... Nicht viel Raum für Fehler......

At the same time, loan terms got looser. For example, in the buyouts of Freescale Semiconductor and retailer Claire's Stores (CLE ), LBO firms peddled bonds that allowed the companies to postpone interest payments until the bonds matured—a previously unheard of feature. Such stipulations applied to 10% of all junk bonds sold in 2007, vs. virtually none 18 months earlier, according to Lehman.

The red-hot demand for even the junkiest of loans allowed many firms to delude themselves into thinking they could endlessly pursue deals. In the three months through July 31, firms announced $254 billion in buyouts, as much as in 2004 and 2005 combined, according to Thomson Financial (TOC ). One credit crunch later, the market for LBO financing has evaporated. Investors won't buy the loans at current prices, leaving banks on the hook for $300 billion in loans to buyout artists.

So far, no big deals have collapsed. The hope is that the credit environment will improve in the fall, and stalled deals will move through the LBO pipeline. But there may be more pain ahead.

HEDGE FUNDS: STEALTH DEBT
Hedge funds helped power the mortgage and buyout booms by hungrily consuming securitized subprime debt and loans used to fund buyouts. By borrowing much of the money they invest, in some transactions up to 90%, hedge funds add another potentially dangerous layer of indebtedness to already highly leveraged markets. Because hedge fund disclosure is limited, huge pockets of leverage are barely visible. This stealth debt helped cause the problems in the subprime market to spread far beyond the housing sector.

One example: the hundreds of billions of dollars in so-called repurchase lines of credit, or repo loans, that Wall Street banks have lent to hedge funds. Disclosure of these esoteric agreements is murky at best, so their precise value can't be quantified. Another tool that pumps up leverage by untold billions is the total return swap. These arrangements allow a hedge fund to capture the gains of a security without having to buy it outright and with only limited collateral.

For some funds, extreme leverage became an acute problem when the mortgage crunch caused banks to doubt the value of the subprime bonds and CDOs the funds held. Banks pulled their lines of credit, forcing funds to come up with the full value of those assets. That caused dire consequences because, in some instances, the funds paid as little as 10 cents on the dollar and now had to come up with the remaining 90 cents. Many funds, including ones from Goldman, Sachs & Co. (GS ) and Renaissance Technologies, were forced to sell better-performing bonds, stocks, and commodities to pay back nervous bankers. ....

Related links from Business Week to the cover story

Main Street Is Fed Up

Bruce Wasserstein: "Expect Lots More Embarrassment"

It's Out Of Bernanke's Reach

Goldman, JPMorgan Stuck With Debt They Can't Sell to Investors

Schadenfreude! Almost on a daily basis news are coming out that the "golden era" that Henry Kravis has described just a few month ago is not so golden anymore......

Kann meine Schadenfreude nicht wirklich unterdrücken. Es kommen momentan fast täglich Meldungen das das sog. "goldene Zeitalter" (Zitat Henry Kravis) für Private Equity bereits einige Monate später weniger golden ist.....

July 17 (Bloomberg) -- Goldman Sachs Group Inc., JPMorgan Chase & Co. and the rest of Wall Street are stuck with at least $11 billion of loans and bonds they can't readily sell.

The banks have had to dig into their own pockets to finance parts of at least five leveraged buyouts over the past month because of the worst bear market in high-yield debt in more than two years, data compiled by Bloomberg show.

Bankers, who just a few months ago boasted that demand for high-yield assets was so great that they would have no problem raising debt for a $100 billion LBO, are now paying for their overconfidence. The cost of tying up their own capital may curb earnings and stem the flood of LBOs, which generated a record $8.4 billion in fees during the first half of 2007, according to Brad Hintz, the former chief financial officer at New York-based Lehman Brothers Holdings Inc.
``The private equity firms, being very tough negotiators, are unlikely to let the banks off the hook,'' said Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York. ``They'll say that's your problem and that's why we're paying you: To take risk.''

As the market began to turn sour last month, Goldman Sachs, Citigroup Inc., Lehman and Wachovia Corp. had to buy $725 million of bonds that Goodlettsville, Tennessee-based Dollar General Corp. was selling to finance Kohlberg Kravis Roberts & Co. purchase of the company for $6.9 billion.

Bonds Tumble
Those bonds are probably worth 94 cents on the dollar, or $43.5 million less than when they were sold on June 28,

Bear Stearns Cos. strategists estimate that about $290 billion of deals still need to get funded, including those of Greenwood Village, Colorado-based credit-card processor First Data Corp. and energy company TXU Corp. of Dallas. ...

>Here are the details from the TXU Deal and i have the feeling that the pricing of the debt could be lots of fun.....

Record Sales
Acquisitions by private equity firms such as New York's KKR and Blackstone Group LP helped push sales of high-yield bonds and loans worldwide up more than 70 percent during the first half of the year to a record $708 billion,

The investment banking fees generated by LBOs in the first half amounted to almost two-thirds of the $12.8 billion paid by LBO firms to Wall Street in 2006, data compiled by Freeman & Co. and Thomson Financial show. In the race to win deals, the five largest U.S. investment banks more than tripled their lending commitments to non-investment grade borrowers during the past year to $174 billion, according to their regulatory filings.

KKR co-founder Henry Kravis in May called it the ``golden era'' of buyouts at a conference in Halifax, Nova Scotia. The extra yield investors demanded to own junk bonds rather than Treasuries shrank to a record low of 2.41 percentage points in June from the peak of more than 10 percentage points in 2002, according to index data from New York-based Merrill Lynch & Co.

No Escape
For loans rated four or five levels below investment grade, the spread over the London interbank offered rate shrank to 2.12 percentage points in February from more than 4 percentage points in 2003. It has since widened to 2.72 percentage points.

Some bankers even speculated that $100 billion LBO was possible, a scenario that is now ``definitely'' off the table,

Just three of the 40 biggest pending LBOs have an escape clause that lets the buyer back out if funding can't be arranged, . A couple of years ago, a majority of deals included a financing contingency, Belin said, based on his research.

Market Cracks
The market for high-yield bonds and junk-rated, or leveraged loans began to crack in June as concerns that LBOs were becoming too risky coincided with a slump in the market for subprime mortgages that caused the near-collapse of two Bear Stearns hedge funds.

Junk bonds lost 1.61 percent last month, the most since March 2005 when General Motors Corp. forecast its biggest quarterly loss since 1992 and the debt lost 2.73 percent, according to Merrill Lynch.

In most deals, investment banks promise to provide loans to the buyer. They then seek other lenders to take pieces of the loans and find buyers for bonds. When buyers vanish, the banks must either buy the bonds themselves or provide a bridge loan to the borrower, tying up capital that would otherwise be used to finance more deals. The banks typically parcel out portions of bridge loans to reduce their risk.

Lending Commitments
Citigroup, the biggest U.S. bank, reported that its securities and banking division recorded an expense of $286 million in the first quarter to increase loan-loss reserves to account for higher commitments to leveraged transactions and an increase in the average length of loans.

Lehman reported on July 10 that its commitments for ``contingent acquisition facilities'' more than doubled in the quarter ended May 31 to $43.9 billion, exceeding its stock market capitalization of $39.1 billion. Lehman said its commitments contain ``flexible pricing features'' that allow it to charge more if market conditions deteriorate.

Goldman Sachs more than doubled its lending commitments to non-investment grade borrowers to $71.5 billion in the year ended May 31.

The biggest concern is ``hung deals,'' where a lender is left holding a large loan to a single borrower, said Azarchs. ``Those traditionally in all the prior credit cycles have caused the greatest amount of grief for the large syndicating banks,'' Azarchs said.

For firms such as KKR or Blackstone, both based in New York, the tighter credit environment may make their acquisitions less profitable and even change the way they go after future targets. Mark Semer, a spokesman for KKR, declined to comment.

``The underwriters are going to be forced to provide bridge loans and it's getting pretty ugly, but Wall Street deserves to get smacked around a little,'' said William Featherston, managing director in high-yield at J. Giordano Securities LLC in Stamford, Connecticut. ``It's been easy for so long.''

Disclosure: short GS, long UBS

Number Of The Day.....Covenant Lite Loans, Toggle Bonds

With an annualized increase close to 1.000 percent in covenant lite loans it is no wonder that private equity can now pay double digit cash flow multiples in their buyouts. Add this toggle number to the mix and you have the groundwork for future trouble.......

Mit einem auf das Jahr hochgerechneten Zuwachs um fast 1.000% in dieser Kreditkategorie die dem Kredinehmer keinerlei gesonderte Auflagen macht ist es kein Wunder das immer wahnwitzigere Käufe von Private Equity getätigt werden können. Beim Hilton/Blackstoen Deal wurde mal eben der 14,5 fache Cash-Flow Betrag auf den Tisch gelegt! Vor kurzem war alles über 7-8 die absolute Höchstgrenze. Wenn man jetzt noch die Nummer der Toggle Bonds hinzunimmt dann kann man erahnen was sich hier zukünftig für Propleme ergeben werden

Bonds that allow companies to pay interest in extra securities instead of cash, including toggle notes, accounted for almost 9 percent of high-yield debt sold this year, compared with less than 1 percent three yearsago

There has been a surge of lending in what bankers call “covenant-lite” loans in 2007. That means that there are no loan covenants that require the borrower to maintain specific financial ratios, as used to be standard.

In 2004, there were just $100 million of such loans. But the total rose to $2.4 billion in 2005, $23.6 billion last year and $103.9 billion in the first half of this year.

In practice, that means the companies that run into trouble need not consult their previous lenders

Public v private equity / Economist

What a great cover! The Cover was originally related to the story the trouble with private equity but it is too great to not put it up. The Economist does a good job of pointing to a view points like pensions etc that havn´t been discussed in the past. It might be true that private equity or as Rodger Rafter would say "pirate equity" has done a good job in the past and has delivered great returns. But i´ve learned that the most important point is to buy cheap and sell high. When i look at the multiples at the deals in the past year and especially in the past 90 days i have the feeling their is a need/rush to "invest" and i doubt that lots of deals will work out to be profitable in the future.

Geniales Cover! Das Titelbild gehört ursprünglich zu der oben verlinkten Geschichte, war aber zu gut um es nicht zu bringen. Der Economist betrachtet hier einige gute Punkte wie z.B. was im die Pensionsverpflichtungen usw angeht die bisher wenig diskutiert worden sind. Es mag ja sein das Private Equity oder wie Rodger Rafter sagen würde "Pirate Equity" in der Vergangeheit gute Ergebnisse erzielt hat, aber ich habe mal gelernt das der Gewinn maßgeblich von einem günstigen Einkauf abhängt. Wenn ich mir die Deals des letzten Jahres und besonders im letzten Quratal ansehe habe ich eher das Gefühl das hier auf Krampf "investiert" wird. Ich denke das die Mehrheit der Deals unterm Strich in der Zukunft als nicht so "smart" angesehen" werden.

BACK in the late 1980s, the Financial Times carried a spoof story about a planned buy-out of General Motors. Nowadays the sale of such a giant would not be regarded as a joke. Every day yet another company seems to succumb to the clutches of private equity. And this week saw what could be the biggest deal ever: a $48.5 billion offer by a consortium of investors for BCE, a Canadian telecoms group. It was swiftly followed by a potential $22 billion bid for Virgin Media, a British cable-television company, and the $26 billion purchase of Hilton Hotels.

Even after those deals, the private-equity titans have plenty of firepower left. According to Private Equity Intelligence, a research group, the industry raised $240 billion in the first half of this year, leaving it well placed to surpass last year's record of $459 billion. That compares with less than $10 billion raised in 1991. In the process, private equity's share of mergers and acquisitions has grown massively (see chart). .....
Public tedium
Life is no longer much fun in a publicly quoted company. Executives have to suffer the slings and arrows of intrusive media coverage, the oppressive tedium of “box-ticking” corporate-governance codes, the threats of activist investors and short sellers, and the scrutiny of single-minded political campaigners.

And what do companies get in return? Traditionally they have had three main reasons to list their shares on a stockmarket. The first is to raise capital, either to expand the business or to allow the founders to realise their wealth. The second is to help retain staff, who can be offered share options as an incentive to stay and work hard. The third involves prestige; customers, suppliers and potential employees may be reassured (and attracted) by the apparent seal of approval given by a public listing. However, all three reasons seem to be less compelling than they used to be.

Historically companies have got their equity capital from four sources: pension funds, insurance companies, mutual funds and retail investors. The first three groups faced legal or regulatory impediments to buying unquoted shares, while the public naturally valued the liquidity a stockmarket listing could bring.

In the absence of a public quote, companies often had only one financial alternative: the banks. In some areas of the world this worked quite well. Banks were reliable partners to Germany's Mittelstand of unquoted companies and to Japan's industrial empires. But in the Anglo-Saxon economies companies often felt nervous about being in hock to the banks. A change in lending policy, due to new management or an economic downturn, could lead to the sudden withdrawal of credit.

Nowadays companies have many more options when it comes to raising money. Banks are much less important as a source of lending; they have been “disintermediated” by capital markets.

Banks might arrange loans, but they quickly offload them to outside investors such as hedge funds. Bond markets are much more liquid than they used to be, and thanks to high-yield products even companies with a poor credit-rating can tap them.

> indeed..... in der Tat....

More securities than ever have the lowest rankings, with CCC ratings assigned to 26.5 percent of the new debt, according to New York-based Fitch Ratings. That compares with 15 percent in 2006 for debt that itch says has a ``high default risk.''

Bonds that allow companies to pay interest in extra securities instead of cash, including toggle notes, accounted for almost 9 percent of high-yield debt sold this year, compared with less than 1 percent three years
ago

Then, of course, there is private equity. It can provide finance at an early stage (venture capital) or as an attractive alternative for companies that have a public quote (the leveraged buy-out). Whereas pension funds will be reluctant to hold a direct stake in an unquoted company, they are willing to pay hefty fees to private-equity firms to invest money on their behalf. .....

> sarcasm?

Mr Motivator
In the 1990s it seemed as though everybody in America had a neighbour or a relation who was about to become a millionaire through their stock options. Companies were handing them out like free newspapers on Piccadilly. Company boards were happy to offer options since accounting rules allowed them to pretend they had no cost. ....

And now that options are properly accounted for, companies are just as happy to hand cash over.

Besides, partnerships such as lawyers and accountants (not to mention hedge funds) have historically managed to offer very generous rewards to their top employees without the need for a stockmarket quote. And private-equity groups have also been successful at retaining important staff by offering them potentially lucrative stakes. Indeed, top executives may prefer the private sector. For a start, private-equity bosses can keep what they earn secret, while chief executives of quoted companies find themselves the subject of impertinent comments from the media and activist shareholders.

Perhaps as a result, managers can earn a lot more in the unquoted sector. The most famous example is Dave Calhoun, a top GE executive who turned down jobs at S&P 500 companies for the chance to run privately owned VNU, a Dutch media group, for a reported $100m package

There is another problem, identified by Professor Jensen almost two decades ago. The structure of a public company creates an inherent conflict between investors and the managers they hire to run the business. The main problem is what to do with free cashflow, the money left over after all profitable investment projects have been funded. In theory this money should be returned to shareholders, but managers may be reluctant to do so. Holding on to cash means they do not have to go cap in hand to capital markets.

Professor Jensen argued that borrowing imposed discipline on executives. They needed to generate cash to meet interest payments. And, if they wanted to finance a project, they would have to convince investors that it was worthwhile. The result ought to be fewer unprofitable projects because cash is no longer left burning a hole in managers' pockets.

Private-equity firms apply this lesson in spades. They gear up the balance sheets of companies they buy with more debt than public firms are willing to accept. Nearly 20 years of economic stability have led some to believe that even notoriously cyclical businesses, such as carmaking, can now bear higher levels of debt. ....
> Some of the latest deals like Hilton, Huntsman etc are already at a double digit multiple...... In the case of Huntsman the bidding company Hexion /Apollo has had a negative cashflow last year and is in debt up to $ 5 billion. When they will get Huntsman they have to take on another $ 10 billion (via Handelsblatt)....... It should be clear that both bidders for Huntsman are rated as junk....

> Einige der letzten Deals (Hilton, Huntsman etc) sind bereits für einen zweistelligen Cashflowbetrag über die Bühne gegangen.......Hier ein paar mehr Fakten zum dem Hexion/Apollo Gebot für Huntsman aus dem Handelsblatt " Hexion wies für das abgelaufene Jahr einen negativen Cashflow und ein Ebitda von gerade mal 439 Mill. Dollar aus. Dem stand eine Verschuldung von fast fünf Mrd. Dollar gegenüber. Je nachdem, wie viel Eigenkapital Access in die Transaktion steckt, müsste das Unternehmen weitere Schulden von bis zu zehn Mrd. Dollar schultern. " .....Es sollte klar sein das beide Bieter für Huntsman bereits al Junkschuldner "ausgezeichnet" sind.......

Workers do have a legitimate concern about the security of their pensions. When a company takes on a lot of debt it undoubtedly makes the “covenant” between a company and its pensions scheme less secure. For a start, it increases the risk that a company may go bust, and so may not be making contributions into the scheme in future. And in the short term executives will concentrate on paying down debt rather than making additional payments to close a pension deficit.

It may well be that the shift away from quoted companies turns out to be detrimental to workers' pensions rights. However, those rights were already being eroded, with many quoted-company schemes being closed to new members or to future accruals for existing employees. Private equity is not the main, or even a leading, cause of the pensions crisis.

The conglomerate model
Another potent criticism of private equity is the parallel with the conglomerates of the 1970s and 1980s, such as ITT, BTR and Hanson. Like private-equity firms, the conglomerates used their financial muscle (in their case, highly rated shares rather than borrowed money) to construct diverse industrial empires. They argued, just as private equity does today, that they could improve the companies they owned through superior management.

Eventually, those empires fell apart. Like a shark compelled to keep swimming forward to catch its prey, they needed ever-bigger acquisitions to make progress. Investors concluded that they could diversify on their own, by buying shares in different sectors. They did not need a conglomerate to do the job for them.

Private-equity groups insist they will not run into the same problem. “We don't hang on to the businesses,” says the leader of one. But that creates another potential problem: investing for growth. If a business is going to be sold within, say, five years, what incentive is there to approve the financing of projects that may take a decade or more to pay off?

Private-equity bosses maintain that it is not in their interest to ruin the companies they buy, because they want to sell them again. And it is also the case that the executives of publicly quoted companies can sometimes skimp on capital expenditure, given that they are often under pressure to meet quarterly profit targets.

Superior returns?
..... One much-cited study** found that average returns, net of fees, were roughly equal to that produced by the S&P 500 index between 1980 and 2001. That implies that private-equity firms do improve the businesses they own, since gross returns outperform the market. But investors do not seem to benefit. “Overall, returns have not been that special, especially if you adjust for risk,” says Richard Lambert, director-general of the Confederation of British Industry, Britain's main business lobby-group. ....

Going private
In addition, private-equity firms need an exit route to sell their investments. Although there is a growing trend for secondary deals, where one group sells a firm it has bought to another, there must be a limit to which further efficiencies can be squeezed out of any particular business. In the end, a public market will be needed for someone to realise their profit.

Indeed, the need for an exit route was neatly demonstrated by the recent flotation of Blackstone, one of the largest private-equity groups, on the New York stockmarket and the decision this week by Kohlberg Kravis Roberts, another of the industry's titans, to follow suit. It does seem a bit hypocritical for these firms, who regularly tout the benefits of the private model, to head for the public markets—but what other route could they take? They could hardly agree to be bought by each other.

A bigger role for private equity might make the economy more vulnerable. Historically, recessions have often occurred when rising interest rates have cut into corporate profits, causing firms to slash employment and capital expenditure. In a world where most companies carried private-equity-style debt levels, companies would be much more vulnerable and recessions might become much more frequent. Monetary policy would become more difficult, with even small changes in interest rates having the potential to cause massive damage to business. And government revenues might be affected if large portions of industry were financed by tax-deductible debt.
But private equity still accounts for only a small proportion of corporate ownership. Much of the industry's activity is among small and medium-sized companies. There is still plenty of scope for private-equity firms to expand.

It may well be, however, that the peak of the cycle is close at hand. Private equity is inevitably a “feast and famine” business: when one fund can raise a lot of capital, they all can. Competition to buy companies then pushes up the price of doing deals, increasing the interest burden and reducing the returns for equity holders. More deals will be done this year, but they may not deliver the kind of returns that investors are hoping for, just as the late 1980s buy-out of RJR Nabisco, the emblematic deal of the era, proved a disappointment.

Since 2003 conditions have been almost ideal for private-equity firms, with low interest rates, lots of liquidity and rising asset prices. But recent events have been moving against them. Bond yields have been rising, making takeovers (which replace equity with debt) more expensive. The high level of corporate profits suggests that there may not be much more to be wrung out of businesses. And the relentless campaign against private-equity tax privileges has made the groups look like easy targets for finance ministers. It may be symbolic that Blackstone's shares quickly slid below the offer price.
Bad debts
Investors also seem to have woken up to the potential risks, perhaps alerted by the losses being suffered in another part of the credit universe—subprime mortgages. They had previously been happy to extend credit on easy terms, such as “covenant-lite” loans (debts with few checks on operating performance) or payment-in-kind notes, where borrowers can substitute more debt for interest payments. Now they are starting to turn down deals where private-equity firms push their luck too far. Banks are getting reluctant to provide the “blank cheques” that private-equity groups were demanding for the bridge financing of deals. In addition, exits may be becoming more difficult: the sale of New Look, a British retailer, collapsed when the last two remaining bidders pulled out.