The hangover from the leveraged-buyout binge has set in. Fifty-three buyouts have ended up in bankruptcy court this year through July. For the whole of last year, the number was 49. And the year before? Two.
It is only getting worse. The number of bankruptcies resulting from LBOs this year is expected to double from last year’s figures. If the economy and the credit markets do not get better, the picture will get really ugly around 2012, when a significant portion of the senior debt of megabuyouts comes due.
What condition the economy and the markets will be in three years is anybody’s guess. But it might be helpful to examine the 53 companies that have already been marshaled into bankruptcy court. Why did they succumb to the recession and the unforgiving markets earlier than others?
I talked to a number of private equity experts and studied the 53 companies in the bankruptcy hall of doom, courtesy of Thomson Reuters. Here are the findings:
1. Sixty percent of the bankrupt companies did LBOs during the height of the credit boom of 2005 to 2007. Most of these companies — such as San Diego-based subprime-mortgage lender Accredited Home Lenders, taken private by Dallas-based private equity fund Lone Star Fund in 2007 for $296 million — are highly leveraged and loaded with debt. “They are purchased at the height of the deal market at the highest prices with the highest amount of debt,” notes Scott Peltz, managing director at Bloomington, Minnesota–based Consultancy RSM McGladrey. “They will be at forefront of bankruptcy filings.”
2. Eighty-three percent are companies with assets of $500 million or less. Only five have assets of more than $1 billion: Beachwood, Ohio–based aluminum and zinc recycler Aleris International (taken private by Texas Pacific Group in 2006 for $3.3 billion); Mississauga, Ontario–based door maker Masonite International (bought by KKR in 2005 for $2.7 billion); Bonita Springs, Florida–based entertainment marketing company Source Interlink Cos. (bought by Los Angeles–based private equity firm Yucaipa Cos. in 2007); automaker Chrysler (bought by New York–based Cerberus Capital Management in 2007 for $7.4 billion); and Spartanburg, South Carolina–based hotel chain Extended Stay (bought by Lakewood, New Jersey–based Lightstone Group in 2008 for $8 billion).
“The small and medium companies are more susceptible to the ups and downs of the economy,” explains Tom Keck, chief investment officer at La Jolla, California–based consulting firm StepStone Group. “They hit the wall faster when things go downhill.” Keck also thinks the fact that these companies were less likely to have a covenant-lite credit such as PIK toggle (a deadly instrument that allows borrowers to defer interest payment) is another factor.
3. From jewelry retailers to automotive suppliers to restaurant chains, consumer discretionary businesses took the worst hit. “A lot of these companies are consumer-dependent,” notes Adam Moses of New York–based law firm Milbank, Tweed, Hadley & McCloy. “They collapsed along with the consumer market last year.” RSM McGladrey’s Peltz adds that these bankruptcies are also happening in industries going through consolidation, such as the packaging and gaming sectors.
To put everything in perspective, there have been 148 bankruptcies involving $389 billion of assets so far this year,
according to research firm Bankruptcydata.com. Did LBOs yield outsize contributions to overall bankruptcies? The jury is still out on that one.
Xiang Ji (Nina) is the capital markets reporter at Institutional Investor, covering mergers and acquisitions, debt and capital markets from an institutional investor’s perspective. Xiang Ji was formerly with BusinessWeek in China covering the wider business world. Send email to capitalbeat@iimagazine.com.
