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The buyout frenzy continues- the latest example being Microsoft's acquisition of aQuantive Inc. for approximately $6 billion- an offer that was 29 times aQuantive's projected 2008 earnings (before special items). At least Microsoft was merely deploying a portion of its $28 billion cash balance held at the end of its fiscal year 2006. Even more baffling is the leverage multiples put up by some of the recent LBO's in the marketplace. Banks and private lenders have loaned a significant portion of the debt in these buyouts- often loaning debt up to 10 times EBITDA- a direct result of the surplus of available funds in the marketplace allowing for "creative" terms for the borrower. Relaxed loan restrictions are allowing companies to be more leveraged than ever before. Sound familiar?

The U.S. has been flirting with the highest default rates on mortgages in years- most notedly the sub-prime market, which is riddled with "creative" terms. Bernanke recently announced that sub-prime loans accounted for more than half of the foreclosures in the fourth quarter of 2006, and delinquency rates rose to 13.3 percent during the same quarter. It didn't take long to begin the finger pointing, as economists continue to worry over the state of the frail economy. Lawmakers have placed the blame at the feet of the Fed and demanded corrective action for their lack of monitoring and controls around sub-prime lending's "creative" covenants. Consequently, Congress and the Fed have already tightened covenants and issued guidance on sub-prime lending, which was published in March of 2007.

Similarly, the high leverage multiples utilized by businesses, especially in the recent LBO's will ultimately cause significant risk to the Companies involved. Shareholders will continue to demand high returns, but how long will companies be able to sustain these returns, which directly affect operations? The value of announced LBOs increased 40 percent to $188 billion in the first quarter of 2007. The Fed issued a warning earlier this week, stating that it sees significant risks in the leveraged buyout boom. In response, regulatory bodies have already turned their attention to the loan covenants within some of the recent LBO's.

The bottom line is that this leveraged buyout frenzy cannot sustain itself in the long run. While the fallout of the sub-prime residential lending will continue to reveal itself in the months (possibly years) to come, the focus seems to have shifted to leveraged buyouts. There is no doubt that sooner or later we will find out if we are creating the next big credit bubble.

Category(s): Valuation Thoughts
Posted by Lauren Hall at 09:25 PM | Permalink | Comments (0) | TrackBacks (0)