When a deal is no longer a deal
As the dissolving buyout of Alliance Data shows, the lack of cheap credit is making last year's happy deals look much less viable.
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NEW YORK (Fortune) -- Alliance Data Systems (ADS) is the latest victim of the buyout bust - but it won't be the last.
Shareholders in the Dallas-based credit card transaction processor lost out on a big payday Monday when their company's $6.4 billion private equity buyout from Blackstone unraveled. The news sent Alliance Data shares down 35 percent in heavy trading. The collapse of the Alliance Data deal came on the same day that student lender Sallie Mae (SLM, Fortune 500) dropped a lawsuit tied to the demise of its own private equity deal. Sallie shares have lost more than half their value since the lender's $25 billion buyout ran aground this past summer.
But shed no tears for investors in Sallie Mae or Alliance Data. Dozens of companies that have agreed to buyouts - from big lender networking company 3Com (COMS) to satellite radio broadcaster XM Satellite (XMSR) and gambling company Penn National Gaming (PENN) - are trading at sharp discounts to the sale prices they agreed to last year. Those discounts reflect investors' doubt that the deals will be completed at the agreed-upon terms - or at all.
Why are so many deals in jeopardy of unraveling? The reasons vary, of course. In the cases of 3Com and XM, for instance, there are political questions: Will regulators allow a Chinese company to take a significant stake in 3Com, which sells computer security software to the Defense Department? Will the Justice Department pursue an antitrust case to prevent XM from merging with rival Sirius (SIRI)?
But in most cases the problem is simply that money is finally getting tight after a long debt-fueled boom. Chris Atayan, a former investment banker who is now CEO of consumer products distributor Amcon Distributing, says investors are skeptical that many of these deals will get done because financing has become difficult to obtain in the wake of last summer's credit crunch. "Spreads are wide," Atayan says, referring to the difference between the price a buyer agrees to pay and the recent quote in the stock market, "because there are questions that are real about whether adequate financing can be found. There is real risk that transactions will have to be negotiated."
When outfits like Alliance Data and student lender Sallie Mae agreed back in May to sell themselves to private equity firms, it was easy to raise money for a buyout. At the time, private equity firms found they could borrow billions of dollars at low interest rates to buy practically any company they wanted. As a result, the price of companies perceived to be interesting to private equity firms rose - which is why an outfit like Sallie Mae, recently trading around $20 a share, initially fetched a buyout offer at $60.
The happy buyout math changed last summer, when the market for mortgage-backed securities collapsed under the weight of growing defaults. The episode reminded investors that loans sometimes don't get repaid, and caused them to demand much higher interest rates for riskier deals - particularly those in which the borrowers were taking on a lot of debt relative to the target company's profits and cash flow.
That shift is making loans to finance these deals more expensive, where money is available at all. And higher borrowing costs cut into the buyer's profit margins - making the outsize buyout prices of last summer unworkable and pressuring the profits of many buyout targets. Sallie Mae, for one, has sharply cut its earnings forecasts since its buyout collapsed.
Of course, plenty of deals are still getting done. On Monday, buyers led by Apollo Management and TPG completed their $17 billion purchase of casino operator Harrah's. And investors aren't skeptical of every transaction. Roche Holdings of Switzerland recently bid $89.50 a share for Ventana Medical Systems. Ventana shares recently traded near $89, indicating Wall Street doesn't expect the big drug company to have any problem closing the deal.
Still, with house prices falling, the economy slowing and banks straining under the weight of bad mortgage loans, there's no sign that raising money for leveraged buyouts is going to get any easier. That's the notion that's leading shares of many buyout targets lower - even if management prefers to seek refuge in denial.
Take Alliance Data. Up until Monday's announcement that Blackstone was backing away from the deal, Alliance Data repeatedly insisted it believed the buyout was on track to be completed. The company issued the latest of these denials last week, when its shares had tumbled a stunning 33 percent below the offer price. Still, the company insisted all was well. "The company believes that the transaction financing remains fully committed by the banking group," Alliance Data said back on Jan. 17. "The company and Blackstone are continuing to work together to close the deal as quickly as possible."
Now, Alliance Data is pledging to fight for the deal. But given the failure of other jilted targets such as Sallie Mae and United Rentals to force their buyers to close deals they later decided they didn't want, investors aren't giving the company much of a chance. ADS shares recently traded at $42 - barely half last spring's buyout price. 
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