The Debt Doldrums

Banks are having trouble syndicating the debt on Europe's largest ever leveraged buyout. Could this spell the demise of large LBOs?

News reports suggest that banks are having to restructure the loans for the buy-out of the UK pharmaceutical chain by US private equity concern, KKR. In other words increase the coupon on the bonds and possibly de-leverage the deal.

Meanwhile, the banks behind Cerberus Capital Management's purchase of automotive group, Chrysler, are also struggling with the financing.

Reports suggest that the banking consortium led by JPMorgan will assume US$10bn in debt and Cerberus and DaimlerChrysler will buy the remaining US2bn. Another US$8bn in loans backed by Chrysler's financing division will be sold.

KKR's financing troubles seem to reflect a general change in sentiment by investors towards LBOs over the last five weeks. At least 35 deals are reported to be undergoing some sort of disruption.

With the backdrop of problems in the US sub-prime mortgage sector, some of the current LBOs are simply proving too rich for investor appetites. Alliance Boots for example is being financed at a leverage of around eight times. The credit committees of banks being asked to buy the bonds can't get the transaction passed their credit committees.

Boots' troubles may well signal a sea change in sentiment. More conservative selection criteria by investors will potentially translate into higher margins on deals and a lower tolerance for high leverage. This in turn will make LBOs more expensive to execute.

If sentiment really is turning it is likely to spell an end to high-profile mega-deals for the time being. LBO firms will have to step back for while until investor sentiment improves.

On the other hand this will give trade buyers, with well structured transactions backed by strong synergies, a better chance of competing against private equity groups. Indeed, investors may feel more comfortable backing such deals, which hinge more on fundamentals rather than clever financial engineering.

A dearth of LBOs could also see equity markets retreat. Much of the strength in global stock markets over the last 18 months has been partially attributed to high liquidity, which has in turn driven LBOs.