Sunday, November 23, 2008

Red Flags Flying at Mega-LBOs


Red Flags Flying After Big Buyouts

Some of the mega-buyouts that private equity shops labored to assemble during the go-go years of the credit boom are coming apart at the seams. These $10 billion-plus deals were usually predicated on expectations that asset prices would rise and debt markets would remain welcoming.

With those hopes dashed, several monster buyouts are starting to fly red flags. Among the biggest, Tribune,looks to be the megadeal most at risk. Sam Zell’s $12 billion buyout of the company, the publisher of The Los Angeles Times and The Chicago Tribune, was financed nearly entirely with debt. Operating cash flow was down by 66 percent in the third quarter. Tribune is on the cusp of breaching its debt covenants, and some of its bonds trade for as little as 9 cents on the dollar. With the advertising market deteriorating in line with the economy, Tribune has few easy options to stabilize its revenue.

Clear Channel, the radio broadcaster, is also deteriorating fast. Bought by Bain and Thomas H. Lee Partners, it has been through the wringer twice. The private equity firms had to pay top dollar to win shareholder approval for their $27.5 billion purchase in mid-2007. Then they were forced to go to court when lenders balked at providing financing. Now, revenue in its radio segment is falling. It was down 7 percent year-over-year in the third quarter, and operating income was down by 20 percent. Citigroup reckons the company’s debt will rise to a crushing 12.5 times cash flow sometime next year.

Many of the problems facing these private companies are shared by their public peers. But leveraged buyouts have less flexibility to weather falling revenue because of their high debt levels. The more lenient debt structures they secured in the good times might buy them some wiggle room. But they do not solve the fundamental business problems that are really threatening the mega-buyouts’ viability.

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