Washington: Buyouts in the tens of billions of dollars were all the rage on Wall Street just weeks ago, but market observers say an abrupt credit crunch has spoiled the dealmaking party.
Days of cheap credit, which fueled a buyout boom, appear to have evaporated as major banks have revealed vast losses tied to risky mortgage-backed securities.
Consequences of a distressed US housing market
Fearing a worsening meltdown in the distressed US housing market, the banks are seeking to preserve cash and curtailing their lending to private equity firms who stoked a buyout frenzy this year.
“I think it’s unlikely the next six months will be as active as the last six months,” said Michael Weisbach, who holds the Golder chair in corporate finance at University of Illinois.
Weisbach, who has just co-authored a study on the financing behind 153 large buyouts, said deals will still occur, but they will likely carry lower price tags.
Deals will take place, but at lower valuations
Just a month ago, private equity giant Blackstone launched a $26 billion (Rs104,000 crore) takeover of the Hilton Hotels Corporation after toasting a partial stock market listing which raked in over $4 billion.
Such deals propelled the Dow Jones Industrial Average stock barometer to a record high of just over 14,000 points in mid-July, partly as investors bid up stock prices on the back of big buyout deals.
Other private equity firms, including Kohlberg Kravis Roberts and The Carlyle Group, also participated in the buyout binge.
Buyout spree will moderate
Joel Naroff, chief economist of Naroff Economic Advisors, who is a consultant to Commerce Bank and advises companies on economic risks, agrees the buyout spree will moderate.
Wall Street shares have fallen hard and fast in recent weeks, Dow is hovering around 13,000 points, as homes sales continue plummeting amid a surge in foreclosures.
Several big banks including Goldman Sachs and Bear Stearns have revealed trading losses or that they had to inject millions of dollars in troubled investment funds.
Stock market slump has made banks more cautious about extending credit which is the lifeblood of private equity firms. Such firms take on debt to buy out companies, hoping they will be able to re-structure them and sell them for a tidy profit within several years.
Home Depot story will impact US market
The financial turbulence, which has made lenders more risk averse, was apparent in a deal mounted by three private equity firms to buy out Home Depot’s wholesale supply division.
Home Depot, America’s biggest home-improvement retailer, had planned to sell its supply unit for $10.3 billion. But it announced on 29August that the deal’s price tag had sunk 17% to $8.5 billion following intense negotiations.
The three private equity firms behind the buyout, Bain Capital Partners, The Carlyle Group and Clayton, Dubilier & Rice, said in a joint statement that they were pleased to have pulled off the deal “in the face of challenging conditions.”
Such conditions did not exist before August when private equity firms were falling over themselves to buy out companies and banks were willing courtiers.
Weisbach said the ongoing fallout will likely affect “the valuations and profitability of some of the deals done in the last couple of years.”
Tougher scrutiny in home/ car loan segment
The credit squeeze is not just affecting private equity firms and their wealthy owners, as millions of Americans are going to face tougher scrutiny applying for home and car loans.
Federal Reserve has pumped tens of billions of dollars into the banking system and slashed the interest rate it charges commercial banks in recent weeks in a bid to keep credit flowing.“The pain isn’t over because the process hasn’t run itself through. It’s a new environment for a lot of people,” Naroff said.