People with money have a tendency to go insane. We all know this.
But sometimes I hear of deals being done that must have been done under the influence of illegal drugs. I don’t know how else to explain this story in Winter (Economic & Market) Watch…..
Like a bad Arnold Schwarzenegger movie, the LBO crowd is right back in the game with another very large takeover, this time Hilton Hotels by Blackstone. The total purchase including the balance sheet and debt looks to be about $29 billion. Typifying just how loonie these transactions have become, HLT has operating income of about $1.2 billion, or a mere 4.1% of the take out price. Assuming $25 billion in debt, that would place debt service at about $2 billion a year. Blackstone plans no divestitures, so the math is straightforward, and the presumption is as well, just borrow the balance. This is definitely the Terminator roulette school of business economics, with now alarming amounts of debt playing the same all or none formula.
For those that did not understand the above, Blackstone took on so much debt to buy Hilton Hotels that the interest payments exceed the income that Hilton Hotels is likely to bring in for the foreseeable future. Granted, Blackstone might have some kind of deal with China, but this is still nuts.
Lenders, in this situation, are essentially taking equity-like risk. They’re looking at Blackstone’s track record, which is stellar, and counting on Steve Schwarzman being able to raise the value of the Hilton brand so much that he can sell it off in five years’ time and repay the loans in full. This is dangerously close to the “greater fool” theory of investing: my loan might not make any sense on its own, but somewhere down the line someone with an even bigger credit line will take me out. As far as I can make out, no one has the slightest intention of actually paying down any of the principal.
Thankfully, not everyone is nuts. The bigger (smarter?) bond market participants are putting their foot down as this Bloomberg story shows….
The world’s biggest bondholders have had their fill of leveraged buyouts, convinced that increasing mortgage delinquencies will drag down the U.S. economy and drive debt-laden companies into default.
TIAA-CREF, which oversees $414 billion in retirement funds for teachers and college professors, is boycotting some debt offerings used to finance LBOs. Fidelity International, a unit of the world’s largest mutual fund company, and Lehman Brothers Asset Management LLC, the money-management arm of the third- biggest bond underwriter, say they’re avoiding debt from buyouts.
Investors are getting skittish just as private-equity firms led by Kohlberg Kravis Roberts & Co. and Blackstone Group Inc. prepare to sell $300 billion of bonds and loans to finance LBOs, according to Bear Stearns Cos. In the past two weeks alone, more than a dozen companies were forced to postpone or restructure debt sales.