The majority of U.S. companies scooped up in boom-era leveraged buyouts continue to struggle as much as five years after they first closed, according to a new study by Moody’s Investors Service.
To make this claim, the rating agency took a look back at the 40 largest LBOs from 2006 to early 2008, including Warburg Pincus’s purchase of Bausch & Lomb and KKR’s acquisition of Dollar General Corp. Of the 40 companies studied, 15 are rated lower than they were at closing, three have filed for bankruptcy, and 16 are rated at the same level. Only five have seen their ratings upgraded.
Moody’s attributes the poor performance to weak revenue growth and high default rates. From 2008 to 2010, 10 – or one-quarter of the 40 firms – defaulted, resulting in either a distressed exchange or chapter 11 bankruptcy filings.
Moody’s warns that these default rates could have been higher had some of the deals not been ‘covenant-lite,’ which means they basically had no covenants or protections built in. Looking back, the fact that lenders wouldn’t slap restrictions on some of these buyouts seems ludicrous. At the time of their closings, the group's median debt-to-EBITDA was a whopping 8.5 times. (That has since come down to 6.5 times as of June 30, 2011.)
Moody’s noted that there has been no clear concentration of defaults by industry. Moreover, total revenue growth from the 40 firms from 2007 to midway through 2011 is just 4 per cent, much lower than the 14 per cent for Moody's broader universe of rated companies.
It isn’t all doom and gloom. There have been some success stories, such as Dollar General Corp., which was originally purchased by KKR, as well as HCA Inc., which was acquired by Bain Capital, KKR and Merrill Lynch. Dollar General has since gone public and recorded the highest earnings growth of the 40 LBOs, putting up growth of more than 100 per cent since the deal first closed.