Ghost of financial buyouts past

To firms planning to buy other companies with borrowed money in the new year: Please take a moment to reconsider and learn from those who have gone before you.
It’s true that companies flop all the time. But those that borrow gobs of money have a narrower margin for error. And companies in some sectors popular for leveraged buyouts, such as technology, media and retail, tend to be those on the thinnest ice. Trends can change quickly, along with a company’s fortunes. This is a good time to reflect on the practice of loading up an already-speculative company with more debt. There have been a few stellar examples recently of how perilous these deals can be.
Consider Avaya Inc., which is struggling under $6 billion in debt, some stemming from its 2007 buyout led by Silver Lake and TPG. Avaya’s technology runs phone systems for office workers and corporate call centers, but customers are gravitating to technology providers that offer flexible software rather than Avaya’s hardware. Avaya’s profits have improved even as revenue has dropped, but the company’s annual operating income is less than the interest payments on its debt.
Perhaps Avaya would have been left in the dust anyway as technology trends changed. But it’s certainly true that an Avaya without the burden of debt payments would have had more financial flexibility to match wits with big competitors such as Cisco and Microsoft and with upstarts including Five9, Huawei and inContact.
Or take a look at J. Crew Group Inc., which is on life support. This retailer incurred almost $2 billion of debt when it sold itself for $3 billion in 2011 to private equity firms TPG Capital, Leonard Green and CEO Mickey Drexler. That deal hasn’t gone so well.
At the end of 2015, TPG Capital cut the value of its stake by 84 percent. Some of the company’s debt comes due in 2018 and investors aren’t expecting to be fully paid back, at least based on bonds that are trading at half the price they were last year.
Or check out iHeartMedia Inc., the radio station chain once known as Clear Channel Communications, which was bought for $24 billion in 2008 as one of the last mega-leveraged buyouts before the credit crisis. The company probably wouldn’t be floundering if it weren’t for the $21 billion of debt it’s struggling to repay. Revenue is stable, albeit not growing. It’s turning a profit. More than 265 million people in the U.S. still tune into iHeart’s stations. The mess left from iHeart, Avaya and other buyouts during the mid-2000s boom are relevant again. This year is on track for the largest number of buyouts since 2007, according to Bloomberg data. Although the number and especially the value of such debt-reliant takeovers have been scaled back since the financial crisis, in some corners it looks as if hardly anyone learned the right lessons from the financial crisis that popped the buyout bubble.
Investors don’t seem worried about the risks of buyouts of companies in fast-changing industries. Technology firms have accounted for nearly one in five buyouts in the US this year, the largest share since at least 2004, the earliest year for such data, according to Bloomberg. And private equity firms have started to layer debt on unprofitable, young software firms with scant track records.
Tech companies have also gobbled the biggest share of leveraged loans on record, and on average those companies have less room for error than ever. For leveraged loan borrowers in the U.S. software and data industries, the companies’ debt-to-earnings ratio before interest, taxes, depreciation and amortization reached 5.3 in the first half of the year compared with 4.2 before the financial crisis, according to a September research report by Barclays.
During this holiday season, there’s a lesson there for those willing to pay attention. Can you really handle the chains of all that debt?

—Bloomberg