Leveraged buyouts and merger and acquisition activity could help continue to drive the primary market in 2006. Mega buyouts such as Sungard, Neiman Marcus and Hertz marked 2005 and next year is set to come out of the gate in similar fashion with the Georgia-Pacific/Koch deal looming. "A trend during the year has been public to private transactions and this has led to more cases where equity sponsors are forming consortia and investing in larger transactions," said Bill Hughes, head of loan capital markets at Lehman Brothers. According to research from Thomas Financial Securities Data, eight of the 10 largest LBO transactions announced in 2004/2005, as of Nov. 29, were consortium deals.
Hertz was bought by The Carlyle Group, Clayton Dubilier & Rice and Merrill Lynch Global Private Equity for about $15 billion; Sungard was bought by Silver Lake Partners, Kohlberg Kravis Roberts & Co., Bain Capital, The Blackstone Group, Texas Pacific Group, Goldman Sachs Capital Partners and Providence Equity Partners for about $11.3 billion; and Neiman Marcus was bought by Texas Pacific Group and Warburg Pincus for about $5.2 billion. According to data from Standard & Poor's /PMD, Securities Data Company and BUYOUTS, as presented by JPMorgan's Rob Kindler, at a conference earlier this month, as of Nov. 29, there was over $129 billion of private equity capital available to invest, as of Nov. 29.
Dan Toscano, managing director and group head at Deutsche Bank, said 2006 could be another blowout year for the market in terms of leveraged buyouts, but warned that effects from the 2003-2004 LBO activity could also affect the market next year. "If you think about it, the rule of thumb is that the first two years are the most critical in leveraged buyouts, which means in 2006, this would be the time for problems to emerge for '03 and '04 class deals," he said. "Leverage levels were rising and the market was getting significantly more aggressive in that time frame. That could strain the market this year, resulting in a rise in default rates." But Toscano noted that many of those companies have deleveraged both through free cash flow generation and initial public offerings. He said Deutsche Bank remains bullish on market conditions for 2006.
Default rates may also affect the direction of credit spreads. Currently, spreads for B rated institutional loans are LIBOR plus 270 basis points and spreads for BB rated institutional loans are about LIBOR plus 180 basis points, according to one banker. Hughes said that if the supply dynamics keep pace with what the market experienced in the fourth quarter, one might think it would begin to put some pressure on spreads as some of the excess cash that resides in CLOs gets absorbed by new issue supply. "The net result would be that fund managers are able to better scrutinize credit decisions as opposed to investing in everything the market has to offer," Hughes said. For the four weeks ending Dec. 22, estimated volume of deals in the market was is about $25 billion, according to a banker, but that number had fallen from about $32 billion the week before as deals started to clear out before the holidays.