Debt Cycle: Late Inning Warning Signals? by David Schawel, Economic Musings
For market participants that were around during the 2006-2007 time period, the last few weeks brought up some memorable M&A names. For instance, this week First Data filed to go public. If you remember, KKR took First Data private in a $29bil deal which was the last “big” one before the crisis. The shareholders did well, and the company was left with nearly $22bil of additional debt, or 9x the amount on its balance sheet before the LBO.
The S-1 filed Monday shows operating profit has grown from $1bil in 2012 to $1.4bil in 2014, but the company has still lost money with interest expense from the debt between $1.7-1.9bil per year. Debt isn’t substantially lower at over $20bil, but arguably a lighter load with EBITDA trending higher. Despite a very untimely LBO in hindsight, First Data has reaped huge benefits of the low interest environment issuing monster leveraged loans and refinancing existing debt at lower costs.
It’s not just First Data, additional pre crisis deals such as Hilton and Sunguard are also expected to file and go public later this year – both deals scrutinized after the crisis but now back in the money.
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Maybe the most fun example is yesterday’s Bloomberg article showing how Hostess Brands is issuing $1.2bil in term loans only two years after acquiring the company in liquidation for $400mil. $900mil of these new term loans will be used to pay the investors a dividend. Crazy? Well, the investors took the risk to invest in liquidation, but this does seem awfully “late cycle” like.
So, are these all warning signs that the debt cycle has gone too far? People are really investing in a Hostess dividend recap after two years? That even the worst deals from 06-07 are emerging looking good? I think there’s arguments on both sides. Economic healing and the benefits of the low rate environment have helped these companies heal & outgrow the debt somewhat, but investors should be cautious.