Buyout bets wane as LBOs kept in check

Buyout speculation that sent credit derivatives on companies from Cardinal Health Inc to Dell Inc soaring two months ago is waning as rising unemployment keeps the takeover revival in check.

The average cost of credit-default swaps on 15 companies including the Dublin, Ohio-based drug distributor and the computer maker founded by Michael Dell has declined 33 basis points to 148 basis points, compared with a drop of 2.5 for a benchmark swaps index. Contracts on Cardinal Health have plunged to 60 basis points from 148.3 on October 25.

Bets on a surge in leveraged buyouts are diminishing as the sluggish recovery limits private-equity and bank deals. While the LBO pace has more than tripled to $133 billion this year from 2009, a record $1.6 trillion of deals were announced from 2005 to 2007, according to data compiled by Bloomberg.

Acquirers have to put up more equity, and the amount of debt that targets take on relative to earnings is less than during the buyout boom four years ago.

“Credit spreads are pricing very high chances of LBOs, yet the feared LBO boom has yet to ignite,” said Alberto Gallo, a credit strategist at Goldman Sachs Group Inc. in New York, who last month recommended investors sell protection on companies with credit swaps that jumped on the speculation. “We are in an environment where growth is accelerating, but remains at a low level. Leverage is scarce and expensive.”

Seagate talks collapse
Seagate Technology Plc, the world’s largest maker of disk drives, said last month it ended talks with private-equity firms for a leveraged buyout and instead authorised the repurchase of as much as $2 billion of its stock. Talks collapsed with buyout firm TPG Capital after the suitor wasn’t able to find other partners to raise enough equity financing, a person familiar with the matter said last month.

Private equity firms are typically borrowing 4.7 times the company’s earnings before interest, taxes, depreciation and amortisation costs, compared with 5.5 times earnings in 2006, according to Goldman Sachs analysts.

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar-maturity government debt fell 1 basis point to 175 basis points, or 1.75 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. Spreads reached a 12-week high of 177 basis points on Nov. 30. Yields averaged 3.76 per cent yesterday.