Everaged buyouts are getting bigger and bolder with every passing day, but few have approached the daring of last month's $13.7 billion acquisition of Univision Communications by a consortium of private equity firms.
Led by Madison Dearborn Partners, the group agreed to pay 16.7 times the Spanish-language broadcaster's operating earnings, almost double the average 8.5 percent multiple for 2006 buyouts. The buyers borrowed all but $4 billion of the purchase price, pushing Univision's debt-to-operating-income ratio from 1.8 to an eye-popping 12.4, the highest many in the buyout game can recall. The average ratio for deals last year was 7.2.
"This is double the normal leverage, and it's the highest I've seen for an LBO," says James Rizzo, an analyst at debt-rating agency Fitch Ratings.
The debt was structured even more aggressively. A $7 billion, seven-year secured term loan contains none of the covenants lenders typically insist upon for protection against the deterioration a borrower's financial health. Most loans require accelerated repayment or force companies into bankruptcy if certain indicators, such as debt-to-equity ratios or cash flows, take a marked turn for the worse. Another component of the financing, a $1.5 billion, eight-year bond issue, lets Univision forgo up to $700 million in interest payments in exchange for increasing the principal amount of the debt and the interest rate. This "covenant-lite" loan structure and so-called payment-in-kind toggle feature are becoming popular in LBO financings but rarely are combined in one deal, bankers say.
The extraordinary risk built into the deal means there's a lot more riding on Univision's future than on that of the average buyout target. The buyout firms have maximum flexibility: Should Univision hit a rough patch, creditors won't be able to force it into bankruptcy or demand early repayment. But in the event of a prolonged slump, the company and its owners will have simply been given more rope with which to hang themselves. The LBO firms won't comment, but people familiar with their thinking say the investors are confident taking so much risk because Univision is growing fast. The company airs such top-rated programming as soccer's World Cup and variety program Sabado Gigante, and is riding a big expansion in the U.S. Latino population. Net income grew by 30 percent last year.
That optimism also shows in the pricing of the debt. The loan, rated B by Standard & Poor's, pays 225 basis points above LIBOR, 17 percent below the average spread for comparable loans. The bonds, rated CCC+, pay 9.75 percent, or 5.2 percent above Treasury securities. The average spread for similar bonds is a fat 11.14 percent.
"Investors liked Univision because it's a niche in the television and broadcasting sector with a unique business growth story," says Anthony Clemente, founder of New York loan investing firm Canaras Capital Management. Because the loans are secured by the company's assets, Univision would need to lose almost half its book value for the debt to be considered impaired.
Deals like Univision's are sailing through the markets because of an abundance of liquidity and abnormally low defaults on risky debt. February was the first month in ten years to see no defaults on high-yield borrowings. The lack of blowups has shrunk spreads so much that investors have little choice but to buy even the riskiest deals on borrower-friendly terms. Even mounting fears about subprime mortgage defaults last month didn't derail Univision's deal.
"As a lender you never like covenant lite, and this deal has nosebleed levels of leverage," says one loan investor who bought into the Univision financing. "But in this market you hold your nose."
The flood of liquidity won't last forever, and that could mean a reckoning for companies loading up on LBO debt today. Univision may keep growing rapidly and manage to support its huge debt load. Others taking part in the buyout boom may not be so fortunate.