First Data LBO puts Wall Street firms in vise

NEW YORK — A group of seven investment banks may get stuck with the tab for this year’s biggest leveraged buyout.
AUG 20, 2007
NEW YORK — A group of seven investment banks may get stuck with the tab for this year’s biggest leveraged buyout. When the $29 billion deal for credit card processor First Data Corp. was announced in April, it looked like another coup for New York-based buyout firm KKR & Co. LP and the banks, which stood to collect millions in fees from selling mountains of junk bonds and exotic instruments. The trouble is that demand for speculative debt has dried up. Even in the spring, “this deal looked like a bit of a stretch,” said Chris Donnelly, an analyst at Standard & Poor’s Leveraged Commentary and Data in New York. Now, he said, “unless the market changes drastically, the only question is how much money the arrangers will lose on it.” With five weeks to go before the deal is slated to close, the banks — Citigroup Inc., Credit Suisse Group, Deutsche Bank AG, The Goldman Sachs Group Inc., HSBC Holding PLC, Lehman Brothers Holdings Inc. and Merrill Lynch & Co. Inc., — have an unpleasant choice: hold on to the debt themselves and risk losing millions if its value falls or walk away and pay penalties totaling $700 million for breaking their pledges. Many observers agree that if the banks can’t sell the First Data deal, it bodes ill for a whole string of LBOs — $330 billion worth, according to Citigroup research — that are to be marketed in coming months. Walking away would appear to be the lesser of two evils, given the dire state of the credit markets. But doing so would incur the wrath of one of the banks’ most important customers: LBO king Henry Kravis, co-founding member of KKR (formerly Kohlberg Kravis Roberts & Co.). “Presumably, they will never work for KKR again if they fall down on this deal,” said Tom Burnett, research director at Wall Street Access in New York. The second choice looks even more unappetizing. The financiers, who are trying to sell $22 billion in First Data securities, would have to assume that debt themselves — a burden they clearly never expected As part of a record $8 billion junk bond offering, KKR is asking investors to accept a feature called a PIK-toggle, which would let First Data repay creditors with either cash or more bonds. Additionally, KKR is trying to raise $14 billion in so-called covenant-lite loans. This type of agreement means First Data would not even have to update its creditors on its financial health unless it wanted to raise more debt. Not surprisingly, the value of similar types of instruments already in the market has plummeted in recent weeks. Last month, the Bear Stearns High-Yield Index, which tracks the value of such securities, posted its biggest drop since WorldCom Inc. of Clinton, Miss., filed for bankruptcy five years ago. “I’m sure the bankers will call in every chit, every favor they have, to move the deal,” said Martin Fridson, president of New York-based debt research firm FridsonVision LLC. “But I just don’t see it getting done with PIK-toggles and cov-lites.” A KKR spokesman declined to comment. Spokesmen for the investment banks either declined to comment or did not return calls. Analysts say the deal has another major flaw. Though First Data, the nation’s largest processor of credit card receipts, is a blue-chip company, the acquisition would saddle it with a crushing debt burden. According to S&P research, the Greenwood Village, Colo.-based company would barely generate enough cash to cover interest payments and capital expenditures. First Data is hardly the banks’ only LBO headache, but simply the first and largest to hit the market since the credit crisis began. JPMorgan Chase & Co. and Merrill Lynch, both of New York, are among a dozen giants that have promised to finance 50 LBOs in the coming months, according to research from New York-based Citigroup. In July, KKR’s proposed LBO of London-based drugstore giant Alliance Boots Ltd. forced investment bankers into a similar corner. Unable to find buyers for all the debt, they shelved the deal. The bill for such unexpected failures is large and getting bigger. Bear Stearns Cos. Inc. of New York could suffer a $940 million hit if it were to sell at current prices all the debt it has agreed to provide for LBOs, according to New York-based securities firm Sanford C. Bernstein & Co. That sum is equal to roughly half of Bear Stearns’ projected 2007 earnings. Investors are watching the First Data deal closely. If bankers balk, a pall would be cast over the prospects of pending buyouts, ranging from that of Cablevision Systems Corp. in Bethpage, N.Y., to that of TXU Corp, a Dallas-based utility. On the other hand, if banks take on the debt from yet another deal that investors no longer want any part of, they could end up damaging their creditworthiness — and their profits. “What this all means for Wall Street is meaningfully shrinking earnings,” said Dick Bove, an analyst with Punk Ziegel & Co. of New York. CNS

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