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Lessons From 200 LBO Defaults

Lessons From 200 LBO Defaults

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Published by: forbesadmin on Jun 27, 2012
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11/08/2012

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SPECIAL COMMENT
CORPORATES
 
 JUNE 4, 2012
 
 
Table of Contents:
Analyst Contacts:
NEW YORK +1.212.553.1653
David Keisman +1.212.553.1487
Senior Vice President
david.keisman@moodys.com
Randy Lampert +1.212.553.2932
 Associate Analyst
randy.lampert@moodys.com
Tom Marshella +1.212.553.4668
Managing Director - US and AmericasCorporate Finance
tom.marshella@moodys.com
Leveraged Buyouts
Lessons from 200 LBO Defaults
Investor recoveries from LBO defaults are in line with those from non-LBOs
»
 
LBOs do not worsen investor recoveries.
The high leverage of LBOs has not translatedinto lower returns to lenders in the event of default. Our review of 200 LBO defaultsdating back to 1988 finds an average family recovery rate of 54%, almost identical to the55% average rate for more than 800 non-LBOs.
»
 
Default type is a key factor.
LBOs defaulted via distressed exchanges and prepackagedbankruptcies more often than non-LBOs. These default types generally produce higherinvestor recoveries than regular bankruptcies or liquidations.
 
Less than half of LBOdefaults in our database occurred through regular bankruptcy filings (not prepackaged),compared with nearly two-thirds of non-LBO defaults.
»
 
Bank debt recovers less in LBOs.
 Although family recoveries in LBO defaults are on par with non-LBOs, the LBO bank debt recovers less because it has a smaller cushion of subordinated debt. Without the use of distressed exchanges – in which the bank debt isusually allocated a 100% recovery – bank debt recoveries would have been even lower.
»
 
 Asset intensity not a major factor.
 Average recoveries are very similar for LBOs andnon-LBOs in both “asset heavy” industries like manufacturing and “asset light”industries like technology. This contradicts the view that asset-heavy companies yieldbetter investor recoveries because they have more assets available to creditors. The likely reason is that lenders incorporate a company’s asset characteristics in lending decisions.
»
 
LBOs avoid liquidation.
LBO companies have been much less likely to liquidate thannon-LBOs, reflecting LBO sponsors’ preference for distressed exchanges andprepackaged bankruptcies, as well as their interest in preserving relationships with banks.
 
 
CORPORATES
 
2 JUNE 4, 2012 SPECIAL COMMENT: LEVERAGED BUYOUTS LESSONS FROM 200 LBO DEFAULTS
LBO recoveries in default match up with non-LBOs
Most research on the topic of leveraged buyouts has focused on the effects of LBOs and on theprobability of LBO defaults. Relatively little has been written about investor recoveries when LBOsdefault.In this report, we find that the high leverage of LBOs has not translated into lower recoveries forinvestors in the event of default. While the LBO sponsors could not spare these companies fromdefaulting – and may have prompted defaults through high leverage – the average family-level recovery rate in these situations was nearly the same as the average rate at defaulted companies that had notexperienced an LBO. LBOs accounted for about half of defaults during the Great Recession, andabout half of the population of companies rated B3 negative or lower at the time.Of the more than 1,000 defaults in Moody’s Ultimate Recovery Database, about 200 occurred atcompanies that had undergone leveraged buyouts. The average family recovery in these LBO defaults was 54%, compared with 55% at non-LBO companies (Fig. 1). This suggests that whether or not thedefaulter was an LBO had little effect on recoveries.
1
To be sure, there are many other factors that canaffect recovery rates, such as company size, industry mix and default timing. But sorting the 1,000-plus defaults in our database solely on the dimension of LBO transactions suggests that LBOs alone donot lead to materially lower recoveries for lenders to sponsored companies.
2
 The 201 LBOs in our sample had an average of $871 million of defaulted debt, matching the averagefor the 805 non-LBO defaulters. The median defaulted debt amount was $407 million for the LBOsand $272 million for the non-LBOs. These data are drawn from Moody’s Ultimate Recovery Database, which tracks recovery rates for more than 1,000 defaults dating back to 1988.In terms of ratings of sponsored companies, we have done previous research
3
indicating that we haveon average assigned ratings appropriately after private equity takeovers. The research has indicated thatdefault rates at each rating level were similar for sponsored and non-sponsored companies.
FIGURE 1
Average Recovery Rates
LBO Count* Non-LBO Count*
Family Recovery
54.13% 201 54.52% 805
Bank Debt
74.96% 251 83.26% 766
Senior Secured Bonds
66.38% 49 66.46% 211
Senior Unsecured Bonds
37.39% 86 40.70% 383
Subordinated Bonds
24.16% 165 30.40% 537
*Unique Tranches of Debt
1
This echoes the findings of our previous LBO research report,Cheating Death: Private Equity Manages Solid Recoveries When Sponsored Companies Default,” which  was based on a much smaller data set.
2
The LBOs in our sample include traditional LBOs by large private equity firms, as well as management buyouts, acquisitions by individuals and smaller equity firms andother structures.
3
 
 
CORPORATES
 
3 JUNE 4, 2012 SPECIAL COMMENT: LEVERAGED BUYOUTS LESSONS FROM 200 LBO DEFAULTS
LBO recoveries perform through default cycles
 A look at the last three default cycles further demonstrates that LBOs do not exhibit unusual recovery characteristics. The bar chart (Fig. 2) shows the three separate cycles in which default rates haveexceeded the historical average. During the three default cycles, average family recoveries were similarfor both LBOs and non-LBO companies, mostly in the low-50% range, further support for the view that LBOs are not inherently disadvantaged in terms of recoveries. In most cases, average family recoveries were slightly lower for LBOs; the one time that was not the case was in the 1999-2004default cycle, in which non-LBO defaults had lower average family recoveries because they includedsome large telecommunications startups that had very poor recoveries.
FIGURE 2
Number of Defaults by Year
0204060801001201987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011Non-LBO LBO
 
Source: Moody’s Ultimate Recovery Database
Choice of default type is a key driver of LBO recoveries
One way that LBOs have achieved this relative parity of recoveries with non-LBOs is through the highproportion of distressed exchanges and prepackaged bankruptcies among defaulting LBOs. As shownin Fig. 3 on the following page, less than half of LBO defaults were regular bankruptcies (notprepackaged), relative to the nearly two thirds of non-LBOs that defaulted via bankruptcy. For seniorcreditors, a prepackaged bankruptcy or distressed exchange typically yields higher recovery rates thandoes regular bankruptcy because only the junior debt typically suffers losses. This is the case becausecompanies experiencing distressed exchanges and prepackaged bankruptcies are usually less distressed, with higher enterprise values, than companies experiencing regular bankruptcies. Further, distressedexchanges are a common way that equity sponsors will initiate a default so as to maximize theownership position they retain in the sponsored company.There are a few more things to note about distressed exchanges. First, distressed exchanges may befollowed by additional distressed exchanges or an eventual bankruptcy filing if the company remainsunder credit stress. Second, our database captures each of these instances of default and counts itseparately. Finally, for purposes of this analysis, our family recovery calculations for distressedexchanges included an allocation of full recovery 
 
for the debt instruments that did not default.Therefore, family recovery rates were typically high in the distressed exchanges, even as the defaulteddebt that was subject to the exchange incurred larger losses.
 

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