While peer Standard & Poor’s has spent much of the last week threatening to downgrade whole countries within the European Union, Moody’s has focused its attention instead on boom era buyouts, and the picture it paints is grim.
The weak financial performance of many large buyouts agreed during the peak of the market, coupled with heavy debt burdens that limited flexibility in the downturn, has increased the risk of default at those businesses and made it difficult for the sponsors responsible to turn a profit, according to new research by rating’s agency Moody’s.
Coupled with a gloomy global economic landscape and choppy capital markets, Moody’s warned it may be difficult for private equity groups to realise returns, especially those invested in buyouts with lower credit ratings.
“Given the significant debt maturities in 2013-2015, Moody's expects sponsors to pursue IPOs, credit agreement amendments and refinancing, but only if the financial markets are accommodating,” it said.
Moody’s studied 40 leveraged buyouts agreed between 2006 and 2008 with a combined value in excess of $400 billion, including Harrah’s, Energy Future Holdings Corporation and car-maker Chrysler, and found that only four had improved their corporate family ratings – opinions of a company’s ability to honour all of its financial obligations – since their buyouts.
The four to improve their ratings were discount retailer Dollar General, car auctioneer KAR Auction Services, private education provider Education Management, and hospital group HCA, Moody’s said.
The report said the “significant downwards rating drift since the LBO dates” was due to the companies struggling with “high initial leverage that limited their flexibility during the recession”. The findings support the argument proposed by many critics of the buyout boom who argued that the amount of leverage being used in those deals was too great.
Moody's also cited soft earnings performance, large near to medium-term debt maturities and debt-financed shareholder payouts as contributing factors to the weaker credit profiles.
Lenny Ajzenman, a senior vice president at Moody’s, said in a statement: “As a group, these private-equity backed companies demonstrated lacklustre performance and have had a high default rate through distressed exchanges. A number of these large LBOs, such as Hawker Beechcraft and HD Supply, have large maturities and remain at high risk of default or balance sheet restructuring over the next few years.”