Published on April 8, 2008
Can you give a run down on the state of the global buyout market?
Former Federal Reserve Board chairman William McChesney Martin once quipped that the central bank's role is to "take away the punch bowl just when the party starts getting interesting". The sub-prime mortgage crisis in the US that triggered the credit crunch the markets are now experiencing acted in many ways as the maitre d' that took away the punch bowl before the party got interesting.
Let me tell you how interesting the party might have been. During the first half of 2007, banks were offering a debt/EBITDA [earnings before interest, taxes, depreciation and amortisation' ratio of 7 on terms known as "cov-lite" or covenants-light. Today if you go to the market you get 3.5X D/EBITDA on first liens financing only.
Cov-lite refers to debt covenants that impose very little financial restrictions, giving lenders little protection if creditors run into difficulties. The cov-lites are high yields, and yielded a good 250-350 basis points higher than their senior secured loans. This market is completely dried up.
What implications does receding leverage have on asset prices?
Say you had three credit cards. Your shopping bills are going to be at a certain (high) level. You're apt to think less about your purchases. Take away two of those credit cards and you are probably going to think harder about your purchases. So the one good thing about the disappearance of easy credit is that asset prices will likely come down to their intrinsic values.
So you think assets that were purchased over the past few years were overvalued then?
Yes. For sure the asset prices purchased over the past two years were valuation-wise higher than the asset prices purchased a couple of years prior to that period.
Price and value of the underlying business can differ greatly. Throughout history we have seen investors participate in the "Greater Fool Theory". It doesn't matter at what price one buys a business so long as one sells it at a higher price. You have to find someone more stupid than yourself to buy the business at a higher price.
So what else has happened after the party?
There was a backlog of roughly US$300 billion (Bt9.48 trillion) worth of loans for leveraged buyouts (LBOs), and this is an estimate mostly just of the US LBO market. Asia-Pacific LBO loans hit a high of $28.6 billion from 31 transactions in 2007, up from $21.2 billion from 23 deals in 2006, according to Dealogic.
I think maybe only a third of this aggregate amount will be honoured under the terms. A third of it will be renegotiated under a Mac-out (Material Adverse Change) clause, and a third of it will simply not go through.
What is your prediction for the buyout market in 2008?
Firstly I think the value of deals is likely to be flat or possibly recede from 2007 levels. This is directly caused by the squeeze in the credit markets.
Secondly, the industry is under closer scrutiny by the authorities and the public.
This is a somewhat a self-inflicted pain as many of these funds have gone and are going public.
Thirdly, there is pressure for private equity funds to be taxed a higher rate.
In the United Kingdom, for example, capital-gains tax payable by the industry will increase from 10 per cent to 18 per cent beginning this year.