Is the End of the M&A Boom at Hand?

Private equity is having a harder time finding investors for risky LBOs. Fallout from a collapsed megadeal could prove worse than the subprime crisis

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The messy market in risky mortgages has made banks much less willing to hand out no-money-down loans or to put cash in the hands of unqualified buyers. But look beyond the subprime problems, and you'll see that the market for shaky corporate debt also has some difficulties just now coming to light. And they may prove to be even more severe.

Far from some esoteric niche of high finance, the new caution around syndicated debt holds immediate ramifications for investors. If a major transaction such as the $29 billion deal for First Data (FDC) or Chrysler's complex go-private acquisition were to collapse, the repercussions on Wall Street would be immense and far-reaching.

Who's Left Holding the Bag

"If one of these big chunky deals that are coming up gets hung, it could put underwriters out of the market for a while," says Steven Miller, head of Standard & Poor's Leveraged Commentary & Data. (S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies (MHP)). If it becomes more difficult for private equity firms to obtain cheap financing, the record pace and price of leveraged buyouts is likely to slow. That in turn could curb prices in the stock market, which have been driven in part by the expectation that many public companies will be taken private at a rich premium.

Just three months ago, investors appeared ready to buy just about anything the bank-loan or junk-bond market could manufacture. But over the past few weeks, investment banks have found themselves unable to sell loans that were designed to fund risky LBOs. As a result, investment banks have been left holding the debt, without others to share the risk (see BusinessWeek.com, 7/10/07, "End of the Private Equity Party?").

"The question is whether investment banks will be able to find a home for the loans that they are committed to or whether they will have to swallow all that debt. We will have a better idea of how the market shapes up after a few weeks," says financier Wilbur Ross. "Some riskier deals that don't have committed financing might not get done" (see BusinessWeek.com, 5/15/07, "Wilbur Ross: 'No Chapter 11 Here'").

Investors Balk at Toggle Notes

So far, the investor backlash has been limited to smaller and midsize deals that employ some of the particularly aggressive financing structures. Investors have soured on deals that rely on so-called toggle notes, which allow a troubled borrower to repay one loan by borrowing more money from another source.

Private equity firm Clayton, Dubilier & Rice has had trouble financing its $7.1 billion buyout of U.S. Foodservice. The Columbia (Md.) company had to scale back a proposed $1.1 billion junk bond deal to $650 million. It also had to shelve plans to syndicate a $3.3 billion loan with toggle notes. That has left banks such as Citigroup (C) and JPMorgan Chase (JPM) responsible and holding all the debt—a position the banks hardly want to be in. Clayton also had to cancel plans for one of the bank loans designed to finance its $5.5 billion takeover of lawn-care company ServiceMaster (SVM) after debt investors balked at the toggle notes.