BEHIND THE NEWS: Tightening credit markets cast shadow over megadeals

August 6, 2007

Almost overnight, the nation's lending climate has tightened dramatically, and the timing couldn't be worse for two Indianapolis companies.

A pair of private equity firms are trying to line up billions of dollars in debt financing to complete their $5.6 billion purchase of locally based Allison Transmission from General Motors Corp.

Meanwhile, locally based Finish Line Inc. plans to rely on debt to pay nearly the entire cost of its $1.5 billion acquisition of Tennessee-based Genesco Inc.

Those deals still may very well happen. But there's reason for concern.

Financial executives say the tough new environment will slow the nation's buyout boom, scuttling many pending deals. To close others, buyers will have to pump in more equity or pay higher interest rates on debt. Unless buyers finagle lower purchase prices, they'll end up stuck with smaller returns.

A recent New York Times headline said it all: "Bam! Easy credit evaporates, and so does the buyout frenzy."

Why the new mind-set? As hundreds of billions of dollars in deals await funding, bankers finally are fretting over how much risk the market can bear. Frenetic competition among suitors has bid up buyout prices to record levels. And because the deals are funded with heavy debt, purchasers have little margin for error.

"Things are still really good" in the overall economy, said Glenn Scolnik, CEO of the private equity firm Hammond Kennedy Whitney & Co. "But lenders are nervous. So they are starting to dial back."

The strains already are showing up in the Allison and Finish Line deals. Last month, Allison's buyers-New York-based Carlyle Group and Onex Corp.-postponed a sale of $3.1 billion in loans they'd planned to use to finance the purchase.

"My guess is [the purchase] will still go through, but they are probably working on a revised capital structure" and maybe a lower price, Scolnik said.

And some Genesco investors are losing faith they'll ever collect the eye-popping $54.50 a share Finish Line dangled for their company. After Finish Line announced the deal June 18, Genesco shares rose as high as $54.14, but they've been swooning since and now fetch just $50.65. If investors thought closing were a slam-dunk, that 7-percent spread would shrink to almost nothing.

Finish Line has done what it can to calm the waters. Before announcing the Genesco purchase-and before credit markets slid into disarray-it lined up a "commitment letter" from Swiss-based UBS Securities LLC for up to $1.6 billion in financing.

Within weeks, however, analysts were wondering whether UBS might pull the plug, spooked by a decline in Finish Line's operating performance, its falling stock price and growing weakness in credit markets. Finish Line shares fell the day the companies unveiled their deal and have continued their slide since. They now trade for $6.50, 48 percent below the price the day before the announcement.

Not to worry, Finish Line officials said in a conference call with analysts June 29. Peppered with questions about whether language in the letter might give UBS the right to extricate itself, Chief Financial Officer Kevin Wampler suggested the investment firm wasn't going anywhere.

He said the letter doesn't give UBS an out tied to Finish Line's stock price. And, when asked if the changing credit markets could give it an out, Wampler said, "Realistically, no. ... UBS has stepped up, and we are fully committed. So we are ready to go."

At the least, however, the uncertainty could force Finish Line to pay higher interest rates. To help pay for Genesco, Finish Line plans to issue $700 million in bonds. But if markets aren't conducive, UBS has agreed to make a bridge loan for a like amount-a pricier form of debt, analysts say.

A recent analysis by Citigroup analyst Kate McShane says that under a best-case scenario for interest rates, the Genesco purchase might boost Finish Line's pershare profit in the first full year by 5 cents. In the worst case, the purchase might cause per-share profit to shrink by 20 cents. She opined that Finish Line "might be biting off more than it can chew."

Other analysts are more bullish on the deal, saying it gives Finish Line access to Genesco's strong stable of mall chains-including Journeys and Hat World-reducing the Indianapolis company's reliance on the topsy-turvy sports apparel and shoe business.

But these days, savvy strategy will get you only so far. As recently as two months ago, bankers were deal-makers' best friends, fueling the buyout mania with cheap credit. Now, if companies like Finish Line and Allison close their deals under their original terms, it will be despite the lending market, not because of it.
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