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Why Aren't There More LBOs?

Tyler Durden's picture




 

With yields compressed to record low levels, thanks to Bernanke's repression, and a consensus expecting margin stability and a huge hockey-stick in earnings going forward, the question is why aren't there more LBOs? Earnings yields relative to high-yield financing is back up at levels seen during the LBO Boom of 2003-7 and Private Equity shops appear full of money on the sidelines, so why aren't there more LBOs? At its simplest level, an LBO is enabled by a relative mis-pricing between debt and equity ‘costs’ that a private equity firm can utilize to fund the deal (cheap credit relative to equity in the WACC). These factors appear defensible but the main fear we have is their sustainability.

 

Our strongest counter to a Public-to-Private boom is perhaps more simple though. The strength of markets in the last year is based on EPS growth (not top line growth) and multiple expansion as firms have crushed costs to maintain some semblance of margin growth (or stability) and Bernanke has flooded public markets with cash. The tendency towards LBOs being driven fundamentally by expectations of aggressive cost-cutting seems far lower in this environment. So whether its policy uncertainty or the reality that firms are massively Cap-Ex under-invested - which is cash flow intensive - PE firms know that acquisitions will need to bleed tons of Cap-Ex during their investment horizon - and no matter how attractive the 'deal', confidence in the future remains low.

 

As everyone awaits the 'done' deal at DELL, we suspect this will not open the floodgates of a new LBO Boom - as even money burning a hole in private equity shop pockets is unwilling just to throw it all away...

 

The benign macro environment of 2004-2007 allowed investors relatively easy access to credit and more efficient risk transfer of credit risk as securitization and derivatization virtuously reinforced one another. We neither have a benign macro environment or a securitization market to offset this highly levered debt - especially as we note the underperformance of HY credit markets over the past month. Cash on balance sheets is offset by the rise in cheap debt that has created it, and natural leverage has been on the rise recently too as cash burn has begun on a top-down basis.

 

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Tue, 02/05/2013 - 10:05 | 3216032 booboo
booboo's picture

Real money is chasing Leveraged Blow Jobs from The Benskanke.

Tue, 02/05/2013 - 12:23 | 3216471 your neighbor
your neighbor's picture

Did anyone ask why aren't there any LBOs in the mining sector yet?

Tue, 02/05/2013 - 14:23 | 3216949 IamtheREALmario
IamtheREALmario's picture

... and why more mines are closing than opening, even though margins are high.

Tue, 02/05/2013 - 10:08 | 3216043 q99x2
q99x2's picture

No way to determine the value of fraud.

Tue, 02/05/2013 - 10:12 | 3216049 drivenZ
drivenZ's picture

Sponsors are also having to compete with strategics...M&A volume has been solid. 

Tue, 02/05/2013 - 11:30 | 3216285 Carl Spackler
Carl Spackler's picture

Equity sponsors have always competed with strategic buyers for non-organic opportunities.  Both have capital to employ.

Tyler's point is a good one...there is Bernanke-cheap debt financing out there, so there should be a mouth watering spreads between cost of debt and cost of equity, but this incentive is not enought to get deals done.  Why?

The market is saying the future is not looking as glorious as Obama's central planning and the crafted messages of his media henchmen would like the sheeple to believe.

 

Tue, 02/05/2013 - 10:13 | 3216051 GetZeeGold
GetZeeGold's picture

 

 

The LBO went the way of the Yuppie.

Tue, 02/05/2013 - 10:17 | 3216055 Dr. Engali
Dr. Engali's picture

How can you have leverage buyouts when you are competing against the Bernank and the world's largest hedge fund? All he needs to do is expand the balance sheet to thirty trillion and he can buy up the whole freaking nation.

Tue, 02/05/2013 - 10:20 | 3216063 TotalCarp
TotalCarp's picture

Point is tho that money is cheap. so "leveraged" part in the LBO becomes basically free,

Tue, 02/05/2013 - 10:22 | 3216067 Dr. Engali
Dr. Engali's picture

Money is so cheap and markets are so manipulated that there are no good value metrics. Cheap money has it's draw backs.

Tue, 02/05/2013 - 10:28 | 3216070 buzzsaw99
buzzsaw99's picture

 

 

LBO

bonus

Cost cutting

bonus

IPO

bonus

 

Most have already cut costs to the bone(us) and IPOs aren't doing very well lately.

Tue, 02/05/2013 - 10:42 | 3216104 IamtheREALmario
IamtheREALmario's picture

PE firms depend on inflation and flipping their purchases to make money. As a small private company strategic buyer what we have seen is the complete overpricing of targets with no ability to get any kind of payback period. What this means is that all acquisition are going either to public company buyers (who use so called investor cash, but is really big bank debt converted to equity) or to PE type firms that use free (low interest) money and are only interested in being able to cover the interest on the debt and then flip the company later to the next fool and ultimately to a public company that uses equity funny money.

The entire concept of value buying no longer exists. There is never going to be a payback period ever again as long a free debt money and so called public money exist. IMO, this has created a massive misallocation of resources that cannot be unwound without a crash and having every single PE firm bust their covernenants and ultimately go bankrupt.... causing their lenders to go bankrupt. Balance would be restored, but at a considerably lower level of so called invenstment.

Tue, 02/05/2013 - 11:21 | 3216262 Omen IV
Omen IV's picture

dont you think the PE pricing model includes a crash on the horizon - where they buy the high yield bonds back at cents ($.25)on the dollar which reduces the implied LBO cost to a value  player level?

they have  reserves of cash in alternate funds for the debt buy back moment and the original equity fund just puts up incremental equity dollars and they have the deal with a blended return that works and possibly additional acquisitions after -that create market share tipping point on additional product pricing power

Tue, 02/05/2013 - 13:29 | 3216744 IamtheREALmario
IamtheREALmario's picture

That is historically how it has been done. Bubbles are created and burst in cycles and money is taken out of the system in chunks. But in "Mr. Feelgood's" market there can be no losers and no bursting of bubbles and there is a reason the free market is gone. Unlike in prior times the Western governments cannot afford more expensive money without a default. They do not have the "real" economy to back it up... so until something breaks, it's Ponzi on doods ...

Tue, 02/05/2013 - 10:51 | 3216150 orangegeek
orangegeek's picture

There's less paper work and you don't need to hire lawyers to hit CNTRL-P.

 

Path of least resistance.

Tue, 02/05/2013 - 10:52 | 3216159 new game
new game's picture

actions speak volumes of the true market of fear.

"put that dirty thing back in its place"...

Tue, 02/05/2013 - 11:14 | 3216242 adr
adr's picture

Private business has a hard time existing with fraudcounting. Publicly traded enterprise can be massively profitable however.

There is your answer. The EPS fraud has been epic over the last four years. Shadow inventory isn't just for housing. Most of the public corporations have produced billion of dollars worth of inventory that was never sold. It all sits in warehouses, but since inventory is an asset now, it helps out Mr CFO.

Can you imagine taking a corproation privavte and finding out they have a couple billion dollars worth of dead inventory. Along with the massive debts that go with it.

The inventory scam, the forward sale scam, the internal sale scam, all to create fake revenue to boost EPS. It has worked wonders and along with Ben funny money, made CEOs and corproate directors immensely wealthy.

LuluLemon is the prime example of a total stock scam. The company is complete bullshit, but championed as the greatest retailer of all time behind Apple. Lulu is eying Europe, not because there is growth there, but because they have hit a wall in the US and need more stores to channel stuff. Euro stores will also allow them to add the EUR/USD trade to fake revenue. The great thing about Lulu is they cut out everyone in the middle gaining massive margin on their product. Selling one $150 Yoga pant allows them to pay the bill for 12 pairs at their cost. With the manufacturing bill paid, they are free to play inventory games to fake the sales on the other items.

I mean if you want to believe that every Lulu store can sell over $20k in merchandise every single day, well go ahead. A rational person who has actually been to a store will tell you it is imposible. There will never be an audit. The crispy books will never be looked into. Lulu will just continue to fake sales and the directors will be happy to keep granting themselves stock at ever higher valuations.

If you could play that game, why would you ever want to go private and ,gasp, actually have to make a real profit to pay yourself.

Tue, 02/05/2013 - 12:02 | 3216381 ekm
ekm's picture

You are outstanding.

Thx for sharing your knowledge with us.

Tue, 02/05/2013 - 12:10 | 3216420 drivenZ
drivenZ's picture

"Can you imagine taking a corproation privavte and finding out they have a couple billion dollars worth of dead inventory"

 

if audit firms are doing their jobs correctly this shouldn't happen. ie, you would have an inventory writedown. Besides anyone doing even the most basic due diligence would see this right away.  

Tue, 02/05/2013 - 14:17 | 3216921 IamtheREALmario
IamtheREALmario's picture

Audit firms don't actually count inventory. They just look at the books and confirm there is paperwork to back things up. If he paperwork is fraudulent then the auditors are helpless... or colluding, depending on the situation.

Tue, 02/05/2013 - 20:33 | 3218305 drivenZ
drivenZ's picture

they do actually count inventory. not always but they should. 

Tue, 02/05/2013 - 11:18 | 3216248 rosiescenario
rosiescenario's picture

So the writer's main point is that companies' management have robbed from the future to keep up their current earnings and stock price and make those options they hold worth something, now.

 

Besides deferred CAP ex I'd bet there been plenty of deferred maintenance, too.

 

So how much of the current "E" in the P/E is real and how much is created temporary cost deferrals????

Tue, 02/05/2013 - 12:12 | 3216430 Whoa Dammit
Whoa Dammit's picture

Good read circa 1988 by Ted Forstmann, the original LBO King:

"Every week, with ever-increasing levels of irresponsibility, many billions of dollars in American assets are being saddled with debt that has virtually no chance of being repaid. Most of this is happening for the short-term benefit of Wall Street’s investment bankers, lawyers, leveraged buy-out firms and junk-bond dealers at the long-term expense of Main Street’s employees, communities, companies and investors."

"Today, however, the rules of prudent investing are being violated again and again. The financial risk inherent in using leverage is being applied to companies, such as those in the oil and lumber industries, already burdened with commodity risk. It is being applied to single-product companies facing the risk of technological obsolescence, to recession-sensitive concerns, and to companies with low and vulnerable operating margins. When high-quality candidates are found, the prices paid are often so extreme that even if projections are successfully met, the companies cannot service their interest expense on a current basis or repay their acquisition debt as it comes due. Watching these deals get done is like watching a herd of drunk drivers take to the highway on New Year’s Eve. You cannot tell who will hit whom, but you know it is dangerous."

http://blogs.wsj.com/deals/2011/11/21/read-ted-forstmanns-1988-rant-agai...

Tue, 02/05/2013 - 14:08 | 3216888 jaygould
jaygould's picture

above chart incorrect - where did author derive #'s ?

Tue, 02/05/2013 - 14:54 | 3217075 Dan Conway
Dan Conway's picture

What do you mean no LBO's?  It might not be called an LBO but when a company issues bonds (leverage) to pay a dividend or buy shares it is basically the same thing.  Look at Costco's year-end special dividend distribution, Altria's dividends, etc to see publicly traded companies engaging in similare activities as LBO funds and without the political whiplash.  At least those companies paying dividends are paying the owners whereas some companies with large stock option outflows to management and board members  and you realize that you are not buying stock but rather some deeply subordinated note masquerading as equity.  Also, stock valuations for most publicly traded companies (even the smaller ones) are trading way above their take-out valuations.  There are plenty of poorly run companies that would be better run if owned by a PE firm if they were only available at a reasonable valuation. 

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