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| Blackstone Chairman Stephen Schwarzman |
Before the onset of the credit crisis last August, observers uncompromised by self-interest or the delusion, that the free lunch had been invented, warned of the risk of buyout firms bulking up acquired companies with excessive debt.
Now, not only are many of the acquired companies listing as investors rush for the lifeboats, the prominent buyout firms have also been brought down to earth.
Despite record assets under management of $102.43 billion - a 47% increase from $69.51 billion a year ago, Blackstone Group LP, the US-based manager of the world's largest buyout fund, said on Monday that fourth-quarter profit tumbled 89% after a ``meltdown'' in the credit markets and it forecast a shortage of financing for takeovers in 2008.
Profit excluding costs linked to its June initial public offering fell to $88 million, or 8 cents a share, from $808.1 million, or 72 cents, a year earlier, when the company announced its biggest LBO ever, the $39 billion acquisition of Equity Office Properties Trust. Blackstone's stock rose 2.9% in New York trading on expectations it will offset the LBO (Leveraged Buy-Out) plunge with growth in hedge funds and distressed debt investing.
``Credit market problems persist and if anything have gotten worse,''Tony James, Blackstone President, said on a conference call with reporters today after the results were issued. ``We're looking to 2009 before we see much of an improvement.''
Blackstone, which has lost 55% of its market value since the IPO, hasn't completed a takeover of more than $2 billion in five months as credit costs doubled and the LBO market shut down. Chairman Stephen Schwarzman, who owns 23% of the company, is trying to close the $6.6 billion buyout of Alliance Data Systems Corp., the Dallas-based credit- card processor, announced in May.
Schwarzman said on Monday: "While full year revenues, economic net income and assets under management reached record levels in 2007, the operating environment in the second half of the year presented significant challenges. Declining equity and fixed income markets negatively affected the valuations of the portfolio assets of the Corporate Private Equity, Real Estate and Marketable Alternative Asset Management segments as of December 31, 2007 and led to lower carried interest and incentive fee revenues, but did not adversely affect our Financial Advisory segment.
Lack of available financing in the US and Europe for large leveraged transactions limited our transaction fees. Difficult market conditions in the US and Europe continue in 2008 and there is little visibility on when these conditions might improve. However, despite the meltdown in the credit markets, we have made eight new private equity commitments since the credit crunch representing $2.7 billion of equity and we expect to continue to see new investment opportunities, particularly in Asia. We will remain disciplined in our approach and will opportunistically purchase well priced assets throughout the globe."
In July 2007, Big 4 accounting firm KPMG said in relation to a slowing in M&A activity that in contrast to the steep dot-com collapse of 2000, the then slow-down would be gradual.
Commenting from a European perspective, Netherlands Corporate Finance Head, Jurgen van Breukelen, said: “The European market remains largely buoyant. The key difference between now and then, however, is the dramatic influence of private equity, which continues to hunt-down stable cash flow, attractive growth prospects and profitable companies.
“Private equity players are accounting for a greater volume of deals being done, but more importantly average private equity deal size is increasing, with the likes of Carlyle and Blackstone highly prominent in Europe”.
Today, US banks are estimated to have $130 billion in leveraged loans, or those supporting private equity deals, that they cannot offload.
On Monday, Carlyle Capital, a unit of buyout firm, the Carlyle Group, was on the brink of collapse following its disclosure last week of defaults on debt obligations and investment bank Bear Stearns was rumoured to be running out of cash, which it denied.
Bear Stearns is the the second-biggest underwriter of mortgage- backed bonds, and plunged $7.78, or 11%, to $62.30, in New York - its steepest drop since October 1987.
Former Chief Executive Officer Alan ``Ace'' Greenberg and current board member, told CNBC that liquidity rumors were "...ridiculous, totally ridiculous." See CNBC video.
Moody's Investors Service downgraded 163 portions of 15 mortgage bonds issued by Bear Stearns Alt-A Trust.
Carlyle Capital said on Monday that it had requested a standstill agreement with its lenders after some of them liquidated almost a quarter of the Amsterdam-listed fund’s $21bn of residential mortgage-backed securities.
The Financial Times says that Carlyle, like many other funds, is locked in a showdown with banks who are reducing their financing lines to funds with big investments in mortgage and corporate securities. But the banks’ attempt to manage their exposure, which makes sense on an individual basis, risks precipitating a systemic crisis.
By cutting back on their lending, the banks are forcing funds to unload securities. At the same time they are increasing the likelihood of a death spiral in the market as funds such as Carlyle’s are selling those debts into a falling market, causing the prices to plunge further, which in turn brings on additional margin calls - lenders requesting payment or additional collateral.
To the extent that banks hold many of those same securities, the banks become victims of their own actions as they mark down their own positions.
Many bonds linked to buyouts are reported to be trading at 70 or 80 cents on the dollar, signalling the level of risk about the underlying businesses.
A New York Times report cites the case of Freescale Semiconductor, which makes computer chips. In 2006 it found itself the object of private equity's affection and the subject of the biggest buyout battle of all time in the technology industry.
Two groups of private equity firms vied for the microchip manufacturer, a spinoff of Motorola that builds most of the computer chips for that company's cellphones. Ultimately, the winning group, led by Blackstone, paid a staggering $17.6 billion, most of that with borrowed money.
Now Freescale is plagued by falling demand from Motorola and billions of dollars in debt related to its takeover. It replaced its chief executive nearly three weeks ago, and its junk bonds recently traded at levels that suggest the company might be unable to pay its debts. The company has said that while times are challenging, it can meet its debts.
Blackstone has $1.4 billion from investors in recent times for a fund devoted to buying bonds and loans at fire sale prices. In his conference call on Monday, Tony James, Blackstone President, said the fund is “100 percent dry powder” and so far has not been tapped for investments.“Our view is that things will get worse before they get better,” James said.
