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Moody's Questions Private Equity Buyout Approach

Moody's Investors Service has questioned whether claims by private equity firms that they invest on a longer-term basis than public companies and are able to attract stronger management teams are justified.

Instead, the ease with which private equity firms are able to use leverage and to extract dividends makes Moody's skeptical about commitments to cut debt or to float firms that have been bought in leveraged buyouts (LBOs), the credit ratings agency said in a report dated July 3.

Private equity firms and their use of debt to achieve high returns have come under the microscope in recent months as LBO deal sizes have grown ever larger and politicians, unions and investors have raised concerns.

"The current environment does not suggest that private equity firms are investing over a longer term horizon than do public companies, despite not being driven by the pressure to publicly report quarterly earnings," Moody's said.

"We also question whether there is sufficient evidence to prove that the higher returns provided to private equity are driven by stronger management teams or because, in a benign and liquid credit environment, leverage by itself can provide substantial returns to shareholders," the agency said.

It said it was particularly worried by the willingness of buyout firms to issue special dividends despite commitments to reduce leverage, sometimes within 12 months of a deal closing.

It cited the downgrades of broadband provider WideOpenWest, bought by Avista Capital Partners, and cable TV provider San Juan Cable, bought by MidOcean Partners, in the first quarter of 2007, after unexpected dividend payments. In Avista's case, the dividend was more than twice the size of the company's initial equity contribution, Moody's said.

The agency said lower equity contributions to LBOs had made valuation more of a challenge, and said it was concerned that debt holders have fewer rights as a result of the erosion of covenants.

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