Betting on buy-outs

How simple it all seemed just a couple of months ago. You bought shares in anything that looked even remotely like a leveraged buy-out candidate. Private equity then duly made an offer. The banks, meanwhile, underwrote the colossal loans required to fund these bids. The deal went through and you banked a healthy premium.

Now many wonder if LBOs are dead. But what about deals that have been announced but not yet completed? Goldman Sachs has identified 22 such targets in the US. On Monday morning, shares in all of them were trading below the respective offers outstanding. At a weighted average discount of 7 per cent, that implies $17bn potentially being left on the table.

The market appears worried that these deals will not happen. At the same time, banks’ shares have been hit by worries that they will be left with a mass of junk loans on their balance sheets. That is certainly a risk. Structured product funds have gone to ground and the banks have an estimated $320bn of commitments outstanding on US private equity deals. Yet it seems incongruous to bet on buy-outs not happening and, at the same time, sell the banks on the basis that they will be left holding the baby.

Not every deal will go through as originally planned. Even if financing is committed, material adverse changes can occasionally scupper buy-outs – Sallie Mae recently raised this possibility with regards to its own LBO. There are also regulatory risks and, as with Franklin Templeton’s stance on TXU, the potential for key shareholders to reject an offer.

A more likely outcome, though, is that the banks will try renegotiating terms with their private equity clients but stand behind their commitments. Those investors who trust them to do that should consider a punt on what might be the last gasp of the current LBO boom.