Few Lessons Learned from Failed LBOs of Recent Years
The market does not appear to have learned many lessons from failed leveraged buyouts over the past 20 years, according to Standard and Poor’s. In the last of a series of Commentaries on “The Leveraging of America,” S&P takes a look back at the The Good, The Bad, And The Ugly of LBOs of recent years.
“Sure, the private equity firms that so often sponsor LBOs have figured out how to take their money and run, thanks to special dividends and the like,” S&P says. “But on most other counts, things haven’t changed that much. If anything, today’s LBOs have pushed the debt envelope even further. We would be hard pressed to identify LBOs in the 1980s that are as leveraged as the ones we’ve seen over the past couple of years.”
Further proof that the market has been overreaching resides in the ratings S&P has assigned to LBOs in the last few years versus those of the 1980s. “While we certainly did assign ‘B’ ratings to LBO transactions back then (such as to Macy’s and Federated), these were exceptions. In the ’80s, and up until recently, the majority of LBOs were structured to reach a ‘B+’ rating. Today, ‘B’ and even ‘B-’ ratings are far more common, and investors seem to regard such ratings as the price of admission.”
So if the risk of loading up companies with too much debt was a lesson that should have been learned, it looks like a lot of people cut class that day.
Another history lesson concerning LBOs is that bad timing can be deadly. You can have a good business with a strong franchise, but if your timing isn’t good, it may not matter, S&P says. “This lesson should be especially clear to companies in more cyclical businesses. Macy’s and Federated were strong retailers, but both found out the hard way that managing a highly leveraged situation going into a recession isn’t the easiest thing to do. In fact, this is often a characteristic weakness of LBOs: no cushion. Highly leveraged companies, especially in cyclical businesses, need to have realistic alternatives available if things take a turn for the worse.”
The problem is companies often think they’ll always have access to more debt or that they can grow into their debt load, S&P says. “Indeed, their models always seem to show that’s how it will work. LBOs must always be mindful that the economy can take a turn for the worse–and capital markets can quickly become less receptive.”
History also teaches that trying to fix a problem company by taking it private through an LBO is not a sure thing.
“Going private may rid a public company of those pesky shareholders that never seem to be satisfied, but dealing with a huge debt burden when your company isn’t firing on all cylinders may be a bigger problem.”
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