News from the Tennessee Valley Business
SUNDAY, APRIL 22, 2007

Private-equity buying bonanza
Bid for Sallie Mae shows good and bad of debt-laden buyout deals

By Rachel Beck
AP Business Writer

NEW YORK — The $25 billion bid for Sallie Mae illustrates why a buyout-driven frenzy is propelling stock prices higher. But it also sends a message that consumers and mortgage holders may find less comforting: All the debt-laden dealmaking could keep interest rates from coming down soon.

Before the bid for SLM Corp., commonly referred to as Sallie Mae, was announced, its stock traded around $40 each. Then came the rumors of private-equity interest, sending its shares up to $46 apiece.

When the deal was announced April 16, its stock jumped to $55. And that’s not even the real payout: If the buyout goes through, shareholders will take home $60 a share in cash.

But there is more to this deal worth noting. The purchase by buyout firm J.C. Flowers & Co. and three other investors is being financed in part with $16.5 billion in debt, a move that will likely knock down Sallie Mae’s credit rating to junk. That would make it more expensive for the company to borrow new funds.

No doubt the Federal Reserve is keeping tabs. Its policymakers have been trying to slow down credit creation as part of their drive to keep inflation from accelerating. But super-sized leveraged buyouts, or LBOs, like this show them how plentiful cheap debt still is.

That could steer the Fed from easing monetary policy soon, which would disappoint those on Wall Street who think a slowing economy and some weakening inflationary pressures will lead to lower rates.

Risk to rates

From the way that investors have been cheering for the record-setting pace of dealmaking, they probably don’t recognize the resulting risk to rates. They’ve largely had a sharp focus on what company is getting bought out and which one might be next.

This private-equity buying bonanza has provided somewhat of a floor to the stock market in recent months, since investors are reluctant to sell shares they think could be bought.

That’s given a huge jolt to stocks, erasing the losses sustained during a temporary, yet pronounced plunge in late February. The Dow Jones industrial average has surged to record levels and other major market indexes are at six-year highs.

The total value of announced buyouts worldwide has reached $275 billion so far this year, exceeding the $131 billion during the first four months of 2006, according to Dealogic. For all of last year, the buyout dealmaking hit a record $745 billion, more than double the 2005 levels.

The biggest global buyout so far in 2007 was $32 billion bid for electric utility TXU Corp, according to Dealogic. Private-equity firms Kohlberg Kravis Roberts & Co. and Texas Pacific Group will put up less than $8 billion in cash and borrow more than $24 billion against TXU’s assets to finance the deal.

The $8.2 billion going-private deal for Tribune Co. by real estate mogul Sam Zell will be almost entirely financed with debt.

Richard Bernstein, Merrill Lynch’s chief investment strategist, warns that the leveraged dealmaking could be “handcuffing” Fed policymakers as they deal with interest rates.

After boosting its overnight lending rate 17 times over the two years beginning in June 2004 to slow the economy sufficiently to thwart inflation, the central bankers have left the rate unchanged since last summer at 5.25 percent.

Bank’s next move

Investors have been anxiously awaiting the central bank’s next move — and hoping it’s a rate cut, given that the economy has slowed significantly from a growth rate of 3.4 percent in 2006 to the 2.2 percent expansion expected this year.

Adding to those expectations has been some tame inflation news. The Labor Department on Tuesday reported that the core rate of the consumer price index, which excludes volatile energy and food costs, rose only 0.1 percent rise in March, the smallest gain in three months.

But Bernstein thinks all the headline-grabbing LBOs show the Fed’s efforts to curb credit creation are “impotent.” The last thing that the Fed might want to do is make borrowing costs even cheaper by cutting rates.

“The more one reads about the mega-LBOs in the works, the less one should anticipate the Fed pre-emptively lowering interest rates,” Bernstein said in a note to clients.

Copyright 2005 Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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