Home Depot Goes To The Movies

When the credit squeeze started to become obvious several weeks ago, one of the first things I said was that pending LBO deals would be canceled, delayed or re-negotiated. One of the largest was the sale of Home Depot's construction supply unit to a private equity consortium; it originally carried a price tag of $10.3 billion.

This deal has now been re-negotiated down 18% to $8.5 billion, plus Home Depot itself is participating in the financing of the deal with $1 billion. Therefore, on a net cash basis, the price is really $7.5 billion, or 27% lower than what was originally agreed upon on June 19, just two months ago. There are approx. $400 billion of similar deals in the pipeline and as the NYT commented in a very interesting article:

The stock prices of companies involved in other pending buyouts are near their deal prices, suggesting that investors expect them to be completed as originally agreed upon. However, when one participant in the Home Depot battle was asked what would happen to the next series of deals, he said: “Study what just happened here. You’ll see this movie again soon.” (bold added)

This is a "real economy" development in the credit market with pretty obvious consequences for asset valuations - in this case stocks and LBO debt, which is no longer available "at the snap of my fingers". And keep in mind that the people involved were the creme de la creme of the PE/LBO business: Carlyle, Bain and Clayton Dubilier. If the banks had to strong-armed them, what are they going to do to the B-team?


P.S. The effective Fed Funds rate is currently much lower than the target set by the Fed (5.25%), as can be seen from the chart below (click to enlarge). This is the rate at which large banks lend one another O/N money in the interbank market.


One observation: The drop in effective Fed Funds below target does not mean that everyone's borrowing costs are now lower - far from it. It actually signals that credit is getting much tighter, or even completely unavailable, for those borrowers that are suddenly being re-classified as risky. This results in large money center banks finding themselves with excess cash that was previously loaned out to the now riskier credits - and nothing to do with it. Therefore, rates go down. Not a good sign...