How bad are the credit markets right now? Worse than 1998, according to the CEO of Carlyle Group’s newly public fund that invests in mortgage-backed securities, which has just received a second lifeline from its parent.
    
While commentators have tried to soothe worries about the credit crunch, Carlyle Capital Corp’s CEO John Stomber came right out with the bad news according to his assessment.
 
“We believe the recent liquidity disruption is significantly worse than the events of 1998,” he said.
 
Stomber of course is referring to the collapse of Long Term Capital Management in 1998, a hedge fund whose downfall roiled financial markets across the globe and led to a massive Wall Street bailout.
    
His assessment is a somber view on the state of the credit markets and of financial institutions. 
    
The situation Stomber is handling at Carlyle Capital Corp. is similar to what KKR faced with its mortgage-related public company, KKR Financial.    

The fact that private equity firms and banks were able to come to an agreement on what to do about Home Depot Supply offers an optimistic view of how the various parties–including some of the biggest names in private equity and investment banking–are able to handle the credit tummult. But if you’re coming from Stomber’s point of view, it’s probably going to get worse before it gets better.

(Photo. Reuters file)

ISS’ report on the TXU deal makes interesting reading, in a retrospective kind of way.

The proxy advisory firm recommends shareholders vote for the deal – because, assuming that the credit cycle has peaked they could be “irretrievably” losing some value if they oppose it.

TXU shareholders are set to vote September 7 on the $69.25 a share, or $32 billion, buyout, struck earlier this year. Since the deal was inked, debt investor appetite for risk has changed beyond recognition. As a result, banks can’t sell down leveraged buyout debt they loaned, so they’re stuck holding the bag and not lending.

Why should TXU shareholders approve the deal? Here’s what ISS has to say:

  “To the extent that the current highly publicized credit crunch is short-term in nature, M&A Insight will tend to discount its impact when evaluating contentious transactions. Our focus, as always, is on long-term shareholder value. That said, high-profile market players with whom we have spoken predict we have seen the last of PIK toggles, cov-lite agreements and jumbo-sized LBOs, at least for the foreseeable future. In that light, it appears KKR and TPG have locked in financing for the TXU buyout at the top of the credit cycle.

“If we have indeed passed the credit cycle peak, then it follows that at least some value will be irretrievably lost if TXU shareholders vote against the proposed transaction. The underwater debt positions of the financing banks are a mirror image of the value accreting to the financial sponsors, and by virtue of the reasonable 15- 25% takeover premium, TXU shareholders.”

The ISS report brings to mind at least one deal in which shareholders voted down a private equity offer during the go-go days of the leveraged buyout boom. Shareholders voted down the $9.25 a share bid for retailer Eddie Bauer Holdings Inc. in February — going against advice from ISS to support the deal. The company’s stock is now around $8.50.

The report also brings to mind the Clear Channel deal, and ISS’ stance going into the final stretch. Shareholders are due to vote on the $39.20 buyout of Clear Channel Communications on September 25. ISS opposed the first two offers, of $36.70 and $39 a share and has yet to state its recommendation on the $39.20 bid.  

Wanna bet what their recommendation will be now?

(Reuters file photo)  
 

The credit crunch has put a damper on the private equity deal party. So is now a good time to sell? For broadcasters, now may indeed be the time.

Take Publisher Hearst Corp., for example. The company, which owns 73 percent of Hearst-Argyle Television, on Friday offered to buy up the remaining shares in the TV broadcaster for $23.50 a share, or $600 million, through a cash tender offer. Hearst-Argyle Television owns 26 television stations across the U.S. including South Carolina’s WYFF.

Broadcast shares have in general been beaten up over the past few months - and had fallen harder than the wider market. A number of ‘for sale’ signs hanging over properties were temporarily taken down, such as Nexstar Broadcasting Group.

So with assets the cheapest they’ve been in months, opportunists could swoop in, as Hearst has done.

Hearst, which has properties including the San Francisco Chronicle and Cosmopolitan (picture from www.hearstcorp.com), is offering a premium of 15 percent over Thursday’s closing price for HTV.

Typical take-out values have been in a premium range of 22 percent to 26 percent above historical closing prices, said Bear Stearns analyst Victor Miller in a research note released Monday, which would suggest a price range of $25 to $25.75 for HTV.

“Is 23.50 enough?” asks Miller in the report. He adds: “…the real issue is whether investors believe there is a significant change in the industry take-out multiples given the disruption in the credit markets and whether the majority of the outstanding shares will vote for the $23.50 offer price.”

One boost broadcasters can look forward to next year is spending by presidential hopefuls on political ads. Some think that could boost M&A if the credit markets improve.

In the letter to Hearst-Argyle’s board of directors, Hearst CEO Victor Ganzi spelt out his arguments for taking the company private:

“The competitive demands of the TV broadcasting industry and changes in the broader media industry, when balanced against the pressures on a public company to deliver short-term results, have convinced us that private ownership of Hearst-Argyle is desirable and will assist Hearst-Argyle in attaining its strategic and business objectives. At the time Hearst invested in Hearst-Argyle, we believed the availability of a public currency would enable Hearst-Argyle to grow through acquisitions, and the transaction where Hearst-Argyle acquired the Pulitzer stations would not have been possible without a public currency. The landscape has changed since that time, and we now believe that Hearst-Argyle should be privately owned. “

Another firm seen as likely for corporate parent take-out is broadcaster Cox Radio, writes Miller. Cox is 65 percent owned by Cox Enterprises, according to data supplied by the parent company. “We still believe Cox Radio is the corollary to HTV”, writes Miller, adding that he believes stocks of Lin TV, Nexstar and Cox will be lifted by Hearst’ move.

(Helicopter photograph from www.hearstargyle.com)

If executives at Orbitz are feeling down about their dismal performance since floating shares last month, they may find comfort in the private equity firm that took them public: while Orbitz is down 20 percent from its offering price, Blackstone has dropped nearly 25 percent since its June debut. Together they’re two of the worst performing offerings this summer.

On the surface, Blackstone, the private equity giant, and Orbitz, the online travel  
Website, have little in common. But there is one key element linking the two: debt.

Blackstone acquired Orbitz when it bought Travelport, electing to spin-off Orbitz after the deal. Like most private equity deals in the last two years, the leveraged buyout of Travelport had Blackstone borrowing a hefty amount. Analysts believe that among the factors hurting Orbitz’s stock is the amount of debt on its balance sheet.

Its easy to blame a poorly performing IPO on uneasy markets, but offerings this summer have actually been a relative bright spot with the likes of VMware or E-House.

Obviously the debt factor for Blackstone is that the firm, like other private equity players, can’t get banks to loan them heaps of money for deals due to the credit crunch.

So the credit freeze has taken its toll on Blackstone and other publicly traded private equity firms while high debt loads have spooked investors looking at private equity-backed companies brought to market — like Orbitz, for example.      

The 10 largest private equity-backed IPOs last year had an average debt-to-equity ratio of 1.6, according to PricewaterhouseCoopers — dwarfing a ratio of 0.1 for offerings that weren’t backed by private equity.

E-House, up about 20 percent since its debut earlier this month, had a debt-to-equity ratio of 0.1, according to IPO Desktop. VMware, which has more than doubled since its August debut, had a ratio of 0.5.
 
By contrast, Orbitz and Dice Holdings have dropped about a fifth of their value since their debuts — with debt-to-equity ratios of 0.8 and 1.5, according to IPO Desktop.

Blackstone was trading at $23.68 on Monday, having debuted at $31 per share in June. Orbitz was trading at $11.96 after going public at $15 per share last month. The apple doesn’t fall too far from the tree.

(Image credit. “The Cleaver Family.” www.geocities.com/alcus2)

So much for walking away from Home Depot.

Though as of this writing no formal agreement was inked, Reuters and other news outlets reported that Home Depot, the private equity buyers,  and the banks agreed to cut the size of the supply division sale to $8.5 billion from $10.3 billion. Upped equity checks and debt assumption were also part of the new deal hashed out over the weekend.

Coming to such agreement was a long and difficult process, but at least it shows that Private Equity Inc.  was not willing to walk away from an LBO deal under fire. If LBO firms were planning to hit the exits on any pending deal, this would appear to be the one.

A theory has persisted around Wall Street that given the impact of the credit crunch and the freeze it’s spread across Wall Street’s lending desks, private equity buyers would simply pay a reverse break up fee and walk away.

Reuters ran this theory by a few Wall Street sources who threw cold water on it, saying that the reputational damage the buyout firms in particular would suffer would be too great. Hypothetically, what would Henry Kravis say to the next CEO he approached about a deal having just backed out of the last one, so the thinking goes. And imagine the lawsuits on a $10 billion plus deal that goes up in smoke?

Deal Journal points out that walking away has happened before and doesn’t appear to have caused permanent damage.

However, a high level banker gave Reuters another reason to doubt the theory. The incentive for buyout firms to walk away comes only with cases where the company they plan to buy has suffered a severe falloff in its business prospects.

That would fit the description of Home Depot Supply, for sure, but do others come to mind? Will Christopher Flowers, known to be among the smartest financial sector bankers around, really back out of a Sallie Mae buyout, or is a game of chicken going on?

The point is, in the LBO deals of the past two years, including the ones announced up until a few weeks ago, the private equity firms got the best terms they’re likely to get. Why walk out on a deal that banks have loaned them huge sums for cheap and with hardly any restrictions? It’s not the private equity firms stuck with the debt, it’s the banks. Yes, the buyout firms need the banks and they may agree to add a covenant here or there to take some pressure off their lenders, but bailing banks out of signed deals is not something their limited partners pay 2 and 20 for. 
    
Take First Data and TXU, for example. These are large LBOs where there are concerns the banks will get stuck with the debt and lose money on the transaction. The banks may like to walk away, but why the private equity firms? First Data, as a payment processor, generates huge amounts of cash, making it prime turf for an excellent LBO with good return potential.
   
TXU is beholden to fluctuating energy prices, sure, but it also a big cash generator. And it appears to be the kind of asset both KKR and TPG would be happy to hold onto for an extended period of time, depending on where energy prices sit.

Walk away? If things get ugly with some of the large buyouts in the pipeline–and they will–you’ll see some high-level and possibly ugly negotiations, but probably not a getaway.

Investors in TXU Corp. - due to vote in just two weeks on whether to sell the company to private equity firms for $32 billion - might want to take notice. The first major power deal in 16 months finally closed on Friday, putting at least a temporary end to a string of failures in the sector.

British power company National Grid, which announced plans in February of 2006 to buy KeySpan Corp. for more than $7 billion, finally made it through its last state regulatory hurdle this week.

The deal was announced amid a flurry of optimism in the sector about consolidation with deals that included Exelon Corp.’s plans to buy Public Service Enterprise Group, Duke Energy’s acquisition of Cinergy Corp., and FPL Group’s proposal to buy Constellation Energy.

Of them, only the Duke-Cinergy deal closed, in April of 2006. The others ended up on the scrap heap late last year as the companies fought with state regulators - newly empowered after a change in federal regulatory oversight seemed to open the door to more scrutiny - and local politicians.

Even small deals have been tough to come by. Just last month, Australia’s Babcock & Brown Infrastructure Ltd walked away from a $2.2 billion deal with NorthWestern Energy Corp. after state regulators had blocked the deal.

The failed deals have cut into M&A in the sector, as corporations look warily at how state regulators - who are tasked with making sure consumers get the best rate possible - will view their combinations.

TXU’s buyers, a group led by private equity firms Texas Pacific Group and Kohlberg Kravis Roberts & Co, have already made it past the state legislators and politicians, but they still need all the good karma they can get.

The buyers have to get past their largest shareholder, Franklin Resources, which has said the deal price is too low. And they have to sell all that debt that goes with the deal in markets that don’t seem too open to massive junk bond deals. Globally, some $330 billion of junk bonds from other leveraged buyouts are still waiting to be sold.

Proxy fights are tough, any way you cut it. Steel company Ryerson won in its proxy fight with Harbinger Capital on Thursday. While the success rate of these battles is around 50-50, John Laide says lately the dissident shareholders are getting the upper hand.

The graph below, provided by Sharkrepellent.net, shows the success rate has been hovering around 50 percent for the last few years.

Laide, research manager at SharkRepellent.net, a unit of FactSet Research Systems Inc., points out that the odds have generally been rising for dissidents. “Since 2005, more than half have been favorable for the dissidents,” Laide said in a phone interview with Reuters. “The odds aren’t so stacked up as they used to be. ”

One reason is that there are more hedge funds in existence, said Laide. “A lot of times…when an activist shareholder targets (a) company, there’s a turnover in the shareholder base with a lot of event-driven investors buying in,” he added. “They buy in and have a pretty good voting stake and that really increases their odds to success.”

Laide added that companies were increasingly not letting the situation even get to a meeting. “A lot of times they’ll work it out beforehand and the fight doesn’t even make it to a meeting,” he said.

In a proxy fight, the pursuer typically goes straight to shareholders to try and persuade them that the management of the company should be ousted in favor of a slate of directors favorable to the acquirer, according to Barron’s Dictionary of Finance and Investment Terms. If the shareholders, through their proxy votes agree, the acquiring company can gain control of the company without paying a premium price for the firm.

Ryerson was victorious in its proxy fight. Ceridian sold itself in a leveraged buyout before it faced a proxy vote. Fights that went the other way include H.J. Heinz Co.’s fight with Nelson Peltz’ Trian Group last year, which ultimately led to Peltz’ fund winning a slate of directors. Carl Icahn, after a long battle with luxury home builder WCI Communities, earned a seat on its board.

Whichever way the fight goes, the trend for more proxy battles has been up. Separate figures from Sharkrepellent.net show the number of fights for board seats has increased to 94 this year, from 87 in 2006 and 39 in 2005.

Directors had better get used to the fight.

If only all companies could be as clear cut as Sigma-Aldrich when it comes to denying market rumors.

When responding to queries about rumors, companies often go with the all too commonplace and not particularly helpful “We don’t comment on market speculation.” Hmmm. Is that a no-comment or a non-denial denial? Or they’ll say something like “We are always considering opportunities and talking to competitors.” Does that mean the rumor is true? To their credit, TD Ameritrade and E*Trade’s PR people, shed a bit more light than normal early on Wednesday regarding their M&A strategies when rumors flew of a potential merger.

Sometimes the company spokesman will go off the record and say something like “There’s nothing here, but you can’t write that.” Helpful, but not so great if the stock is up and the options are moving around like crazy.  

And then there’s Sigma-Aldrich CFO Michael Hogan.

When faced with  market speculation that his chemical company was interested in acquiring German specialty chemicals company Altana - a rumor that sent Altana shares up 6 percent earlier today - he just told it like it is.

“I will tell you there are no discussions taking place with Altana…the rumors are false,” Hogan told Reuters. And he didn’t stop there.  ”We had a call from Altana, because they were as perplexed as we were,” said Hogan.

And then this.  
     
“To give you an idea of how untrue the rumors are, I had to look Altana up to figure out who they are,” Hogan told Reuters.

Aha. That’s definitely a denial. Check that rumor off the list. Altana shares gave up most of their gains, closing up only about 2 percent in Germany. 

   (With reporting by Euan Rocha)
     
    

A lot has been written lately on the credit crunch, it’s impact on the private equity industry, M&A and the potential woes facing both LBO firms and their investment bankers.
   
Little has been written about the corporate boards that, by foresight or luck, sealed fat premium deals before the leveraged buyout (LBO) market dried up. So, on that topic, here comes a bit of ink. 

If you’re a shareholder who thought the long term prospects of your company promised a doubling, even tripling of your money, then you have a right to gripe. But if you were simply looking for a nice, quick return on your investment, then the boards who got LBOs done in the last few months are looking pretty good right now.
Wireless company Alltel comes to mind. The company was up for sale this spring, with several teams of private equity bidders pursuing the company. First and second round bids were penciled into bankers’ calendars, with the process expected to spill into late-spring, early summer. But to the surprise of those following the deal, Alltel announced on May 21 that it agreed to be bought by TPG Capital and Goldman Sachs for $25.7 billion–a 9 percent premium to where shares were trading the day before but $10 above where the stock was trading before news of a deal leaked in the weeks before.

The company took some heat when news spread that the auction was cut short. But had the auction stretched just two months more, with back and forth bids, would Alltel still fetch $71.50 per share in cash from LBO firms?
                                                                                                      

Or how about Ceridian? Pershing Square, the hedge fund run by William Ackman wanted the company to split itself up, which prompted an auction for the whole company. Ackman was furious, insisting that the company was worth more if Ceridian, a payment processor, broke itself up rather than sell the whole thing to what would likely be a private equity buyer. Sure enough, private equity firm Thomas H. Lee Partners and Fidelity National Financial offered $36 per share in May for all of Ceridian, an offer that the board accepted. Ackman fought the deal throughout the summer, until Aug. 14, when he agreed to bless it, citing market concerns.

What if Ceridian had rebuffed THLee, in hopes of stoking a bidding war with Ackman or another buyer, hoping to seal a deal around, say, August? Ceridian’s $36 per share purchase price was, given the circumstances, probably as good as it would get. Hindsight is 20/20 of course.

The list goes on of companies whose deals now look timely: Chrysler, Hilton, United Rentals.

Those are examples of boards who may seen a closing window for a knock-out offer. And then there is WCI Communities. The home builder resisted Carl Icahn’s $22 per share offer for the company, saying in May it could find a better offer. On July 26, when the private equity industry was officially cut off from access to easy debt, WCI said it failed to find a willing buyer. The stock dropped 21 percent. Its current share price as of this posting: $8.24.

In the major leagues of the stock market, H&R Block’s management is a weak-hitting shortstop.

That would appear to be the unusually tart assessment of Institutional Shareholder Services, an influential proxy advisory firm that smacked H&R Block Wednesday by throwing its support behind a group of dissidents led by former SEC Chairman Richard Breeden.
    
Now, it’s one thing for a tough-talking activist hedge fund manager to toss grenades at the target of his investment affections. Breeden Partners since late June has waged a campaign to elect three directors, arguing that management has put H&R Block in the cellar with ill-considered expansion into subprime mortgages, banking and brokerage.
 
ISS piled on.
    
“We conclude that the company’s long-term underperformance can be traced to either a failed diversification strategy or poor execution,” ISS said in its report.
 
But the harshest criticism came as ISS compared Block’s boardroom record of more misses than hits to Mario Mendoza, a former major leaguer with a lifetime batting average of .215, who–fair or not–is synonymous with weak hitting.
    
“Of course, companies should be free to test out new concepts and need not bat 1.000 when taking risks. However, it appears that H&R Block has batted below the “Mendoza Line” when it comes to its diversification strategy,” ISS said.

According to baseballlibrary.com, Mendoza was a good fielding shortstop who hit below .200 three straight seasons, 1975-77, and five times over a nine-year career. He played most regularly in 1979, where he hit .198 in 373 at-bats through 148 games for the Seattle Mariners.

But Corporate America is like baseball in one other way: Under-performing players are eventually replaced by proven veterans , see the New York Yankees, or a new hot prospect. In any case, with investors and analysts wondering if Block is a takeover target, it might not be long before Chief Executive Mark Ernst is heading for the showers.

(Image. Mario Mendoza, from www.baseball-almanac.com)