Big money, big deals, big concerns, big caveats. That appears to be one logical deduction from the news that ratings agencies S&P and Moody’s have both downgraded the credit rating of office supplies giant Staples Inc., pushing it into junk bond territory.
S&P dropped Staples from BBB- to B+. Moody’s pushed it down to B1, and its senior unsecured rating even lower, from Baa2 to B3. And this comes after the announcement at the end of June that private equity firm Sycamore Partners had entered into a definitive agreement to buy Staples for US$6.9 billion. “With an iconic brand, a winning strategy, and dedicated and passionate associates who are deeply focused on the customer, Staples is truly an outstanding enterprise,” Stefan Kaluzny, managing director of Sycamore Partners, said in the original announcement.
Apparently, S&P is not as enthused. Their research note declared: “Staples will issue about $4.25 billion of new debt and Sycamore will contribute $1.6 billion of common equity to fund the B2B [business-to-business] buyout transaction. The transaction will result in meaningfully weaker credit metrics at Staples.”
Debt is of course the lifeblood of leveraged buyouts (LBOs). But not even the staunchest buyout titans deny that LBO debt does put a substantial burden on acquired assets, and the ratings agencies are clearly not impressed by the buyer’s plans to revamp Staples’ business enough to pay off all that debt.
Furthermore, according to other commentary in the legal press, Staples’ shareholders have launched at least two class action lawsuits, claiming that Staples and its board failed to include, or misrepresented, key information in its proxy statement to investors concerning the buyout proposal.
Obviously, private equity funds with the amount of cash on their books that I talked about last week will be shopping around for opportunities like Staples, where they can put their billions to work.
Staples, meanwhile, obviously does need some kind of business turnaround support after its failed merger bid with Office Depot, to revitalise its operations and position itself to compete more effectively in future.
But clearly, one kind of investor in one kind of asset class is not as convinced of the value of a private equity investment as another kind of investor in another asset class. The analysts and evaluators of actual listed businesses appear a lot less enamoured of buyout investments than the pension funds and other institutions that are busy ploughing their money into private equity funds.
And you don’t have to be S&P to do the math. Asset prices at all-time highs? Institutions piling into private equity funds to fuel deals that drive asset prices even higher?
How much turnaround upside do you need to generate to overtop an already dizzy peak?
I wouldn’t necessarily buy that for a dollar, let alone $4.25 billion.
