Credit market column-more on LBO

The previous posting described the general structure of an LBO transaction. Today's Credit Markets (http://online.wsj.com/article/SB122113907477223393.html) column in the Journal touches upon the effects of the current credit crunch on LBO transactions. You might recall that private equity firms secure a bridge loan from banks prior to actually "LBOing" a target firm. The article discusses what happened when two private equity firms (Thomas Lee Partners and Bain Capital- not mentioned in this article) took over Clear Channel Communications (CCC - http://www.clearchannel.com/). Part of the bridge loan agreement (also known as the credit agreement) written at that time, required CCC to issue $1,400 million ($14 billion) in junk bond aimed at retiring the bridge loan. Unfortunately, the market refuses to buy these bonds at the current situation and the bonds have to be issued in chunks. The current intended chunk is $980 million. Even when these new bonds were discounted to 70% of face value, the underwriters who market these bonds for CCC were able to find buyers for only $228 million.

What are the implications of this inability to sell these junk bonds? CCC cannot repay the bridge loan. Most bridge loan agreements prevent the lending bank (or syndicate) from suing the private equity firm so the banks are stuck with a huge loan that was meant to be short-term in nature. The numbers are staggering: as you can learn from this article, banks are stuck with $48 billion of bridge loans that carry relatively low interest rates.

The Saga of CCC is long. You can go for example to a previous June 14 Journal article (http://online.wsj.com/article/SB121336291248771553.html). I am quoting from article so that you can familiarize yourself with the concept of PIK or toggle bond.

“The $2.31 billion of Clear Channel bonds are split between a pay-in-kind toggle note, which allows a company to make interest payments in debt rather than cash. Such a bond is risky for investors because, should the company run into trouble and go bankrupt, it has the potential to leave them with more debt and lower recoveries.”