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Debt crunch puts buyouts in jeopardy

Clear Channel, Sallie Mae and other deals await completion, but investors signal doubts about the terms.

August 20, 2007|Thomas S. Mulligan | Times Staff Writer

new york -- Like airplanes backed up on a runway, dozens of pending multibillion-dollar corporate buyout deals involving such familiar names as Hilton Hotels and Clear Channel Communications are waiting to take off.

But if Wall Street's instincts are correct, the global credit crunch may ground some of them. Plunging stock prices of companies that have already agreed to be bought at higher values suggest that investors believe some deals could be shaky.

There's more at stake than big year-end bonuses on Wall Street. Any fallout from a string of busted buyouts could hit a lot of ordinary people, experts say.

That's because a slowdown in merger activity and the scrapping of existing deals could hurt the overall stock market, which rode the frenzy of buyouts the last few years led by investment banks and huge private equity funds. Declining stock values could sap consumer confidence and consumer spending, which in turn hurts the economy and ultimately puts people out of work.

What's more, so many Americans are invested in the stock market through their IRA and 401(k) accounts that, even if their jobs are safe, their retirement savings could suffer.

"This is a classic crisis of confidence, not a problem with economic fundamentals," said James Bianco, a Chicago-based bond analyst and investor. "But that doesn't mean it couldn't cause harm."

The Federal Reserve stepped in Friday to try to calm markets' frayed nerves by cutting the interest rate at which it lends to banks. The Fed said it acted because "financial market conditions have deteriorated" as lenders pulled back from extending credit in recent months.

Stocks rallied Friday, and the trend this week may show whether investors -- and lenders -- are regaining confidence.

Market pessimists say there is more pain to come as banks and investors cope with the hangover from years of easy credit and a blase attitude toward risk. Future deals, when they come, will be done at lower prices, at higher interest rates and with more realistic -- that is, harsher -- terms for borrowers.

More optimistic analysts say that, although home sales and prices are falling from record highs, rising mortgage defaults -- the root cause of credit concerns -- aren't as pervasive as the investor reaction would suggest.

It's also hard to get a fix on how severe the financial markets' problems are because August is the slowest month on Wall Street, and things could change after Labor Day.

In the meantime, scores of buyout deals are waiting to close.

Among the higher-profile ones are radio giant Clear Channel Communications Inc., which agreed to be sold for $19.5 billion to investors Thomas H. Lee Partners and Bain Capital, and hotel chain Hilton, which plans a sale to Blackstone Group for $26 billion.

On Friday, Clear Channel shares closed at $35.07 and Hilton ended at $44.74, reflecting discounts of 11% and 6%, respectively, from their buyout prices. Both stocks have bobbed around in recent days but were up in Friday's rally.

More mega-deals are awaiting completion today than at any other time in history, thanks to the frenzied competition earlier this year to take companies private in leveraged buyouts.

Citigroup analyst Prashant A. Bhatia has counted 47 pending transactions valued at $1 billion or more, led by private equity firm Kohlberg Kravis Roberts' record $37-billion agreement to buy the Texas-based electric utility TXU Corp.

"The backlog will take several months to clear," Bhatia said. "The volume of deals will slow down and very big deals won't happen at all."

The spreading turmoil shows how interconnected the global financial markets have become, with the increasing convergence of laws, currencies and Internet communications. Ripples from the crisis in the riskiest part of the U.S. mortgage market, involving so-called sub-prime home loans because they are made to people with poorer credit, splashed across borders to Asia and Europe and across investment sectors to the seemingly unrelated market for corporate bonds.

What's happening with mortgages affects corporate bonds because, in many cases, the investors are the same people. A hedge fund that borrowed money to invest in mortgage-backed securities and is now facing repayment demands from its lenders may be forced to sell its corporate bonds to raise cash. That pushes down bond prices, even if the corporations issuing the bonds are doing good business and have no trouble making payments.

Many of the pending buyouts were cooked up last spring when the spreads -- or difference in interest rates -- between the yields of super-safe Treasury bonds and riskier, high-yield "junk" bonds were at near-record low levels of less than 3 percentage points, according to economist John Lonski at Moody's Investors Service. Since then, he said, spreads have widened to about 4.3 points.

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