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LBO funds might be poised for a comeback Assets large again, with new players joining usual sources; 'A lot of money raised'; Buying power judged much greater than that seen in 1980s

THE BALTIMORE SUN

When Best Products Co. declared bankruptcy for the second time and shut its doors forever recently, the usual suspects got the blame: fierce retail competition, flat consumer income, flat consumer spending.

But Best, whose demise put 10,000 people out of work, got an extra shove down the retail trash chute.

Nine years ago, leveraged buyout firm Adler & Shaykin acquired the catalog showroom chain for $1.1 billion -- more than 90 percent of it borrowed. The resulting mortgage payments were impossible for Best to meet; analysis by Baltimore's Alex. Brown & Sons for a bankruptcy court showed later that the buyout terms should have set off alarms all along Wall Street.

Best downsized, reorganized, recapitalized and tried to make a go of it, but it never recovered.

Neither did hundreds of other firms. Buoyed by a strong economy and a sea of "junk bond" financing, LBO artists wrecked the balance sheets of companies from coast to coast, gave the 1980s decade its reputation for greed, and financed college tuition for the children of countless bankruptcy attorneys.

Now, as if to celebrate the 10th anniversary of LBOs' "Barbarians at the Gate" golden age, investors are laying the tinder for another explosion of high-debt deals.

LBO funds are newly flush with cash, some of it from usual sources such as pension managers and other institutions, some of it from new players such as banks and rich families.

"There certainly has been a lot of money raised," said Jamie McDonald, a principal for Alex. Brown who works with East Coast buyout firms. "By some estimates, there is something like $50 billion in uninvested buyout-fund capital out there right now."

Assuming that's true, she said, "you're talking about $200 billion of buying power."

That's almost 10 times the value of the biggest buyout deals ever, such as the notorious $26 billion takeover of RJR-Nabisco in 1989.

The only thing holding back a flood of LBO deals is the rich stock market; managers are reluctant to buy in at today's high corporate prices.

But many analysts say that a recession or a market decline of, say, 20 percent would undam a torrent of leveraged buyouts, placing the technique again on the country's political agenda, perhaps putting American companies at risk.

"A lot of buyout firms are praying for a correction in the market," said Kopin Tan, editor of Buyouts, a weekly newsletter.

And some imply that, given the amount of money looking for a home, leveraged deals will happen anyway, at prices that might not make sense for the buyout targets.

"Too much money is chasing too few deals; that is certainly the case," Tan said.

"There's tremendous pressure on these groups," said Doug Schmidt, a senior vice president at Ferris, Baker Watts, a Baltimore investment house. If they can't find deals, he said, "you either refund the money or you don't raise any more."

Analysts and LBO firms themselves argue that the lessons of the 1980s have not been forgotten.

Typically in an LBO, investors buy an entire company, often taking it private from the public stock markets. They put up a fraction of their own money, borrow the rest and use the company's assets for collateral. Dozens of Maryland companies, from the big Halethorpe brewery to London Fog Corp. to Jos. A. Bank Clothiers, were saddled with damaging LBOs.

But fewer financiers these days are using 90 percent "leverage," as buyout debt is called. And LBO investors are said to be seeking constructive growth for their buyout subjects, not the breakups and attempted lightning profits that typified the 1980s.

"While capital is awash right now with regard to acquisitions, I think people have become prudent out of necessity," said Jim Griffin, vice president at the Carlyle Group, a Washington LBO firm whose biggest fund has about $280 million of its $1.3 billion capital invested. "The highly leveraged transaction is, I think, kind of by the wayside. They closed that window back in the 1980s."

But some worry that the trend isn't constructive.

High debt requires high interest payments, which divert corporate funds from operations and other internal uses and which, if delinquent, lead to bankruptcy or some other wrenching recapitalization.

U.S. tax laws still favor debt financing, with its deductible interest, over stock financing, with dividends taxed once as corporate profits and again as income to shareholders.

And many corporate finance chiefs still regard debt as a cheaper form of capital than stock equity, even with today's inflated stock prices.

But those concerned about the LBO funds' flush arsenals would rather see America capitalized with patient equity, whose dividends can be cut or eliminated in tough times, than impatient debt with stiff interest schedules.

"To load corporations with debt for the purposes of playing these little monopoly games that LBO artists play is generally not good for our country," said Sen. Byron L. Dorgan, a North Dakota Democrat. "They're not interested in manufacturing or producing anything. They're interested in making some quick money."

The wave of money funneling into LBO funds has been attracted by remarkable results. Big funds such as those run by Kohlberg Kravis Roberts, Donaldson Lufkin Jenrette and others have reaped returns of 40 percent and more in recent years, having bought companies at good prices in the early 1990s and resold them to today's eager public-stock investors.

"There's just a huge amount of capital looking for a home," said Patrick O. Ring, managing director of the Baker-Meekins Co., a Baltimore-based financial advisory firm specializing in family firms. "The returns expected in the public markets are not as interesting as what's perceived to be available in the private markets."

Baker-Meekins gets several solicitations a week from investment funds looking for deals, many of them leveraged buyouts, Ring said.

In 1995, LBO firms raised $18.4 billion for potential deals, up from just $5.2 billion in 1992, according to Buyouts. Nobody expected 1996's take to match that, said editor Tan.

It did. Last year, buyout firms took in $23.2 billion, prompting more predictions that the take couldn't keep rising. It has. "From the way it's going in the first few months, I would say there's a very good chance we will exceed that number," Tan said.

zTC Now the money needs a roost. The 6 percent coupon on the Treasury bills in which much of it is being stored yields perhaps a fourth of the annual return LBO investors are expecting.

But finding bargains is hard.

U.S. corporations are flush with cash and inflated stock, either of which they can use to finance acquisitions. For LBO firms, "it's no contest," said Ferris' Schmidt. "Over and over again, the LBO funds are finding that corporate prices being paid are beating their prices."

But the funds are looking anyway -- carefully, they say, wisely. But looking.

Like many funds, Carlyle Group is confining itself to industries that it knows well: defense, real estate, technology. It is resisting the temptation to move a lot of money with a few big deals.

Carlyle, whose partners include former Secretary of State James A. Baker III, former Defense Secretary Frank C. Carlucci and former budget chief Richard Darman, is perhaps the biggest LBO player in the region, with large stakes in Howmet Corp., Columbia-based GTS Duratek and others.

Other recent buyouts include KKR's $600 million acquisition of KinderCare Learning Centers Inc. and Blackstone Group's purchase of UCAR Global Enterprises. The Baltimore area is less of a focus now for LBO firms, Schmidt said, because its older, capital-intensive businesses lack the growth that LBO firms want, and its growth sectors, such as Internet firms and other communications companies, lack the assets to act as collateral.

One risk, in addition to the high prices companies are demanding these days, is the business cycle. The country is in its seventh year of economic expansion, and people like Griffin ,, worry that the overdue recession could trip up buyout subjects. But LBO players say they are finding acquisition candidates that they like.

"They've always managed to come up with deals, even when the market is tight," said Buyouts' Tan.

At the same time, the LBO industry insists that the barbarians of the 1980s are now eating off plates and using napkins.

For one thing, they say they're putting much more equity into the companies they buy than in the past. Even 50 percent equity isn't unusual. That reduces the debt service and frees up cash for growth.

"I think that you could generalize and say the amount of leverage is far lower today than it has been, in general, in the past, though every deal has a unique structure," said Alex. Brown's McDonald.

Although she said that "only time will tell how smart the deals are," McDonald said that today's LBO investors "really are looking to grow companies. They're not getting in there to bust them up and sell the pieces."

But neither are they long-term investors.

The typical LBO partnership has a finite life -- 10 years say. It must raise its investment money, find buyout targets and resell its stake before it expires. A typical turnaround time this decade has been two to three years, Griffin said; now it's "more toward a three- to four-year hold period."

It's that kind of strategy that concerns people like Dorgan, particularly when the amount of pent-up buyout money is so high, and when U.S. commercial banks increasingly are helping to finance the debt portion -- and in some cases the equity -- of leveraged buyouts. LBO deals involving savings and loans helped cause the S&L; crash of the 1980s.

"The pressure for them [banks] to put their money to work by making loans is strong once again, so once again you see banks, particularly the larger groups, loosening their standards," said Schmidt.

Schmidt doesn't see a return to the bad old days, however.

The deals of the 1980s "were based on wild growth assumptions, ridiculous growth assumptions," he said. "There was a spiraling effect in the late '80s. Banks kept lending, and the leveraged buyout groups kept extending their parameters. So when the bottom fell out of the economy they had to pay the piper."

What's more likely than a bunch of catastrophes, industry players said, is simply that LBO funds will yield lower profits.

"A lot of people are getting deals done," McDonald said. "The tougher question is whether deals are getting done at valuations that will provide the kind of returns that are typical of this generation of funds."

People like Dorgan, however, worry about a worse outcome.

"There's not much attention being paid on Capitol Hill to this issue," he said. During congressional hearings on LBOs and junk bonds in the 1980s, Dorgan added, "I can recall Secretary of the Treasury [Nicholas] Brady sitting before the House Ways and Means Committee, and he said, 'Gee, I don't see any problem at all.' "

Pub Date: 5/04/97

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