While a chilly response to recent bond offerings for U.S. Foodservice and Dollar General indicate there's a new caution around highly leveraged deals, observers disagreed as to whether it also signaled a slowdown for private equity buyouts in general, or even waning interest in acquisitions of food-related companies.
As reported in SN last week, U.S. Foodservice scrapped plans to sell some $3.6 billion in bonds and loans intended to fund its sale from Ahold to private equity firms Kohlberg Kravis Roberts and Clayton, Dubilier & Rice when bond investors found the terms too risky. More recently, KKR adjusted a bond offering to pay for its acquisition of discount retailer Dollar General, reducing the amount of pay-in-kind toggle notes that would have given the company the ability to pay for its bonds with more bonds.
Those incidents highlighted what one debt analyst called “uncertainty in the market,” stemming from concerns over subprime mortgage-backed bonds and rising interest rates. Those fears crystallized in the U.S. Foodservice deal, which analysts termed too risky because of the high price the firms agreed to pay for the business.
“The U.S. Foodservice transaction ran into problems because KKR and Clayton Dubilier offered to pay a big multiple for it — 13 times EBITDA of $546 million — while the publicly traded competitors, Sysco and Performance Food Corp., are trading at 11 times EBITDA,” one high-yield analyst, who asked not to be identified, told SN. “The investors in U.S. Foodservice expected a sale price of $5.5 billion, but it sold for $7.1 billion. Did they overpay? That's the question the market is asking. The sale price, combined with cap ex and interest expense, means they will not be able to generate any free cash, so there's too much leverage there.”
The analyst added, however, that the incident was not an indication that private equity will lose its appetite for buyouts.
“You saw [Apollo Management] buying Smart & Final, with plans to acquire some of the Henry's locations from Whole Foods if the Whole Foods-Wild Oats deal goes through — an example of a previous equity investor buying more supermarkets,” the analyst added. “So there's still interest among investors.”
Carla Casella, a high-yield analyst with JPMorgan Securities, New York, said she anticipates that private equity deals may decline, “but we haven't seen it yet. The high-yield market has weakened, and it's been trading down, and we've seen one deal — involving U.S. Foodservice — pulled and not going to issue right now. And there are other deals where there have been structural changes or covenant changes made to make them more attractive to buyers. So all implications are it's becoming tough to finance LBOs. And if that situation is prolonged, then it might affect private equity markets, though it's still too early to say.”
Another bond analyst noted that if market jitters continue, supermarket companies — long considered a defense investment sector — could become more attractive targets.
“In an uncertain environment, a private equity shop might be more inclined to go after a stable, defense investment like food rather than something sensitive to interest rates like the auto industry or housing,” said the analyst, who asked not to be identified.
Analysts said they expect U.S. Foodservice will wait for market conditions to improve before making another attempt to sell bonds. Until then, its debt will reside on the books of the buyout firms and the banks that financed the deal, including Citigroup, Deutsche Bank, Goldman Sachs, JPMorgan Securities, Morgan Stanley and Royal Bank of Scotland.
Additional reporting: Elliot Zwiebach