Big Buyouts Are Likelier to Default: Moody's

Jenny Anderson|The New York Times

Apparently, bigger isn’t always better — especially on Wall Street.

The 10 largest companies bought by private equity companies are performing worse than similar stand-alone companies or smaller private equity deals, according to a new report from Moody’s, the rating agency.

Four of the 10 companies have defaulted on their debts, one is about to, and at least three have done special deals — called distressed exchanges — to reduce the debt loads placed on them by private equity transactions, the report says.

“It appears that when you do a large dollar value transaction and you lever that company up, you seem to be at more risk of having problems in a downturn,” said John Rogers, a senior vice president at Moody’s and the lead author of the study.

The report found that deals by two private equity firms, Cerberus and Apollo, have performed the worst among their peers. Four of Cerberus’s six buyouts are in distress or in default, and about two-thirds of Apollo’s companies are in equally dire straits. Moody’s defines default as the nonpayment of debt on time and it includes various types of debt exchanges. Representatives for Cerberus and Apollo said they had not seen the report so could not comment on it.

In the go-go days of easy credit, private equity firms could borrow more money at cheaper rates, enabling them to buy bigger companies, which they then saddled with more debt. During the height of the boom, Cerberus bought Chrysler for $25 billion; Apollo and TPG bought Harrah’s Entertainment for $31 billion; and Goldman Sachs, Kohlberg Kravis Roberts and TPG bought the Dallas-based power producer TXU — now named Energy Future Holdings — for $42 billion.

When the credit markets froze and the economy stalled, these companies faced the double whammy of a global recession and enormous debt loads.

The Moody’s report concludes that about 19.4 percent of companies bought by the 14 largest private equity firms from January 2008 to September 2009 have defaulted, slightly more than the 18.6 percent default rate for similarly rated companies (a rating is an evaluation of the company’s creditworthiness, or likelihood of default).

But Moody’s concludes that those companies are at higher risk than companies not owned by private equity, with almost 20 percent having a very low rating and negative outlook, compared to 14 percent for similarly rated companies. “The default rates may be similar now, but in the future they may be higher,” Mr. Rogers said.

The report concludes that private equity firms invest virtually no capital in the companies they buy, especially those in distress.

It warns that many of the companies owned by private equity face significant refinancing risks in the next one to three years as more debt comes due.