Of the tens of billions IN leveraged-buyout debt that banks will bring to an increasingly wary market in the coming weeks, few deals will be trickier to pull off than the sale of $24 billion in loans and bonds backing the LBO of First Data Corp. by Kohlberg Kravis Roberts & Co. A handful of big investors have learned tentative terms of the deal, which is set to come to market by September, and the reaction hasn’t been encouraging. Specifically, people close to the transaction say that some portfolio managers are balking at the lack of maintenance covenants — which protect lenders against the deterioration of a borrower’s financial condition — on First Data’s $14 billion term loan. Unless the banks behind the deal raise the interest rate, initially set at 2.5 percent above LIBOR, investors may pass on the loan.
Buyers are spooked for a number of reasons, one being the aggressiveness of the First Data deal, which at $29 billion would be the third-biggest LBO in history. KKR agreed to pay 27 times First Data’s estimated 2007 earnings, compared with an average multiple of 22 for similar companies. The $24 billion in debt KKR is piling onto the company is equivalent to 10 times its cash flow — 40 percent higher than the already-inflated average for recent LBOs — and exceeds the value of First Data’s entire market capitalization just a few weeks before the deal was announced.
Debt investors also are worried about a glut of low-quality loans that has hit the market in the past two years — specifically covenant-lite loans like First Data’s. Some $82 billion in such loans has been issued so far in 2007, more than triple the 2006 total, according to Lehman Brothers. Last month rating agency Standard & Poor’s dealt a blow to existing covenant-lite paper, warning lenders that the recovery value of such loans in the event of a bankruptcy would be 10 percent less than that of loans with covenants. The report could curb the appetite for covenant-lite loans or at least prompt investors to demand higher interest payments to reflect the increased risk.
“We’re pushing back,” says David Tesher, an S&P credit analyst. “We’re placing more power into the lenders’ hand to charge a risk premium for covenant-lite loans.”
Fears about credit risk are already hurting buyout financings. Last month investors sent the LCDX North America index — a benchmark for leveraged loans — down from more than 100 cents on the dollar to 97.75. Several companies had to retool aggressively structured debt offerings. Among these was U.S. Foodservice, a food distributor being acquired for $7.1 billion by KKR and Clayton, Dubilier & Rice, which delayed a planned offering of $3.36 billion in bonds and loans, potentially leaving underwriters Deutsche Bank, Citigroup, Goldman, Sachs & Co., JPMorgan Chase & Co., Morgan Stanley and Royal Bank of Scotland Group on the hook to finance the buyout.
“Investors are saying to the banks that they have reached the threshold,” says René Canezin, global head of high-yield trading at Lehman Brothers. “Either come up with lower leverage or higher spreads.”
The outcome of the First Data deal and other big LBO financings coming through the pipeline over the next several weeks will help determine whether the buyout boom will run out of gas. KKR will get its money; its bankers, led by Citigroup and Credit Suisse, have committed to finance the deal regardless of whether they can off-load the risk by selling pieces of the debt to investors. That’s standard treatment for a very important client that has already paid nearly $275 million in fees to Wall Street this year, ranking it fifth among LBO firms, according to research firm Dealogic. First Data, for its part, protected itself by negotiating an unusual reverse breakup fee that requires KKR to pay $700 million to First Data if it fails to close the transaction. But if investors demand a discount to the debt’s face value, the investment banks will have to reach into their own pockets to make up the difference between what they paid KKR and what they receive from the market. That, in turn, would make them far less likely to be as generous on future deals.
