LBO funds might be poised for a comeback Assets large again, with new players joining usual sources

'A lot of money raised'

Buying power judged much greater than that seen in 1980s

May 04, 1997|By Jay Hancock | Jay Hancock,SUN STAFF

When Best Products Co. declared bankruptcy for the second time and shut its doors forever recently, the usual suspects got the blame: fierce retail competition, flat consumer income, flat consumer spending.

But Best, whose demise put 10,000 people out of work, got an extra shove down the retail trash chute.

Nine years ago, leveraged buyout firm Adler & Shaykin acquired the catalog showroom chain for $1.1 billion -- more than 90 percent of it borrowed. The resulting mortgage payments were impossible for Best to meet; analysis by Baltimore's Alex. Brown & Sons for a bankruptcy court showed later that the buyout terms should have set off alarms all along Wall Street.

Best downsized, reorganized, recapitalized and tried to make a go of it, but it never recovered.

Neither did hundreds of other firms. Buoyed by a strong economy and a sea of "junk bond" financing, LBO artists wrecked the balance sheets of companies from coast to coast, gave the 1980s decade its reputation for greed, and financed college tuition for the children of countless bankruptcy attorneys.

Now, as if to celebrate the 10th anniversary of LBOs' "Barbarians at the Gate" golden age, investors are laying the tinder for another explosion of high-debt deals.

LBO funds are newly flush with cash, some of it from usual sources such as pension managers and other institutions, some of it from new players such as banks and rich families.

"There certainly has been a lot of money raised," said Jamie McDonald, a principal for Alex. Brown who works with East Coast buyout firms. "By some estimates, there is something like $50 billion in uninvested buyout-fund capital out there right now."

Assuming that's true, she said, "you're talking about $200 billion of buying power."

That's almost 10 times the value of the biggest buyout deals ever, such as the notorious $26 billion takeover of RJR-Nabisco in 1989.

The only thing holding back a flood of LBO deals is the rich stock market; managers are reluctant to buy in at today's high corporate prices.

But many analysts say that a recession or a market decline of, say, 20 percent would undam a torrent of leveraged buyouts, placing the technique again on the country's political agenda, perhaps putting American companies at risk.

"A lot of buyout firms are praying for a correction in the market," said Kopin Tan, editor of Buyouts, a weekly newsletter.

And some imply that, given the amount of money looking for a home, leveraged deals will happen anyway, at prices that might not make sense for the buyout targets.

"Too much money is chasing too few deals; that is certainly the case," Tan said.

"There's tremendous pressure on these groups," said Doug Schmidt, a senior vice president at Ferris, Baker Watts, a Baltimore investment house. If they can't find deals, he said, "you either refund the money or you don't raise any more."

Analysts and LBO firms themselves argue that the lessons of the 1980s have not been forgotten.

Typically in an LBO, investors buy an entire company, often taking it private from the public stock markets. They put up a fraction of their own money, borrow the rest and use the company's assets for collateral. Dozens of Maryland companies, from the big Halethorpe brewery to London Fog Corp. to Jos. A. Bank Clothiers, were saddled with damaging LBOs.

But fewer financiers these days are using 90 percent "leverage," as buyout debt is called. And LBO investors are said to be seeking constructive growth for their buyout subjects, not the breakups and attempted lightning profits that typified the 1980s.

"While capital is awash right now with regard to acquisitions, I think people have become prudent out of necessity," said Jim Griffin, vice president at the Carlyle Group, a Washington LBO firm whose biggest fund has about $280 million of its $1.3 billion capital invested. "The highly leveraged transaction is, I think, kind of by the wayside. They closed that window back in the 1980s."

But some worry that the trend isn't constructive.

High debt requires high interest payments, which divert corporate funds from operations and other internal uses and which, if delinquent, lead to bankruptcy or some other wrenching recapitalization.

U.S. tax laws still favor debt financing, with its deductible interest, over stock financing, with dividends taxed once as corporate profits and again as income to shareholders.

And many corporate finance chiefs still regard debt as a cheaper form of capital than stock equity, even with today's inflated stock prices.

But those concerned about the LBO funds' flush arsenals would rather see America capitalized with patient equity, whose dividends can be cut or eliminated in tough times, than impatient debt with stiff interest schedules.

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