Waiting for the LBO boom

Only weeks ago leveraged buyout fever was sweeping through the credit markets. But the boom hasn't yet materialised, and the company that triggered the speculation remains in public hands.

Rumours, that US computer maker Dell was a target for private equity groups, first surfaced in January, and an official bid by founder Michael Dell and Silver Lake Partners was announced a few weeks later. The news of a possible LBO caused a dramatic deterioration in the company's credit profile - Dell's spreads widened from 180bps to 400bps in the space of a week.

However, Dell and Silver Lake have not had it all their own way. Major shareholders have opposed the move to take the firm private, and another bid - led by private equity group Blackstone - came soon after.

Dell's spreads recovered some ground in the following weeks, but were still trading in excess of 300bps, giving it an implied rating of 'B', according to Markit data (Dell has an average rating of 'BBB').

The wide spreads indicate that the market views an LBO as a probable outcome. But Blackstone won't be involved after it announced that it was abandoning its offer. The private equity firm said it was concerned about the declining PC business, which fell by 14% in the first quarter from a year ago, according to figures from research company IDC.

Dell's finances were also thought to be a problem for Blackstone - the company has cut its earnings forecasts significantly this year.

One might expect that Blackstone's withdrawal would be positive for Dell's credit standing. But the reaction in the CDS market suggests otherwise. Dell's spreads widened 23bps to 350bps, making it one of the worst performers in the US today.

Why would the withdrawal of one private equity offer be credit negative? Because there is still one offer outstanding, and that is now more likely to succeed. Blackstone's proposal implied a lower leverage than the Dell/Silver Lake bid, and would therefore have been less damaging from a credit perspective. Blackstone's rationale for pulling out was hardly reassuring and probably added to the spread widening.

Even if Dell does eventually get taken private - and that is not a foregone conclusion - it is far from inevitable that a swathe of LBOs will follow. The US economy is in a better state than it was a year ago, but recent data indicates that growth could be uneven this year. Private equity groups prefer a stable, growing economy, and deteriorating corporate profitability can make them think twice, as we saw with Blackstone today.

However, there are factors supportive of leveraged deals. The funding climate has improved, particularly in the US; CLO issuance is up and bank balance sheets are better capitalised. If the Dell deal does go through, we can expect the LBO rumour mill to start whirring and idiosyncratic risk to be a feature once again.

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