Monday, August 27, 2007

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...


  1. Yes, the creme de la creme of scum bag PE outfits. Bain Capital, Mitt Romney's erstwhile firm. Yuck!
    Nice piece.

  2. Bank loans are tied to the Federal Funds Rate. Bank savings accounts are based on the effective rate.

    The spread between the two is a direct subsidy to the banks.

    I'm not sure how I feel about this. On one hand, the Federal Reserve was happy to dump a lot of money into the system when the effective rate briefly spiked above the Federal Funds rate on August 9th. But, the've been happy to let it drop below the effective rate for the last couple of weeks.

    I guess the Federal Funds rate is a cap? Or, it's okay for the market to set interest rates when it's below the Federal Funds rate but not above?

    Maybe I'm ticked that the Federal Reserve is getting in the way of my schadenfreude.

    I'm guessing more than a few CFO's decided to max their companies credit lines in the first part of August and dump the money in nice, safe T-Bills or bank accounts "just in case". Better to go bankrupt owing a billion than a million.

    I bet a few more CFO's decided that it may be a good idea to hold onto a little more cash rather than pay down debt.

    Maybe the Fed is increasing the pain threshold for companies who are "playing it safe". Maybe they are just trying to figure out what the "market rate" is before they cut. Maybe they just dumped too much frigg'n money on the 9th and over shot the mark.

  3. What do you think about Sallie Mae LBO?


  4. Re: SLM LBO

    Market is telling us they will "go to the movies", too. LBO bid was $60/share, now trading at $50. It could also end up as a complete bust.

  5. Dear Hellasious
    what is your comment on the exceptional authorisation given by the Fed to Citi and JPM to borrow up to 25 bn $ to cover liquidity needs among their subsidairies (citi capital market) ? My view is that the Fed is preparing for them a liquidity net that they will need to use (loss of confidence of their creditors) when they will announce massive losses in September

  6. Re: $25 billion authorization.

    The wages of sin for doing away with Glass-Steagall. In effect what is happening is that depositors' money is being used to shore up brokers and their customers.

    This is going to get real ugly.

  7. Hi Hellasious,

    Back to work after a couple of weeks holidays (the french way...).

    Looks like the feeling is changing by the day.

    Any chance that the fed intervention may suffice to re-inflate the bubbles. I have the strange feeling that is too late.

    It the damage is done and everybody waiting for the ugly to come up now?

    Any risk of panic in the old meaning of this word in the US?

  8. Why doesn't Bernanke drop the interest rate, screw the dollar, and inflate his way out of the hole, sendin the stock market to the moon, and then hope like heck he can stop the galloping inflation?

    It's better than tanking the economy here and now, isn't it?

  9. Re: drop rates, screw the dollar, send $ to the Moon...

    I think this will be my topic tomorrow - stay tuned...


  10. The 'Gold Bugs' wet dream....Inflate or Die....

  11. Screw the dollar? Hahahahahahahahahahahah!

    It's more like they would be SCREWED BY the dollar. Here's what happens when the government "screws the dollar." NO MORE FOREIGN CREDITORS?

    You think you've seen monetization of debt and general price inflation Just wait until the U.S. government has to buy it's own debt because no one else will?

    And say bye bye to the petro dollar regime, and say hello to $200 dollar+ for a barrel oil?

  12. I think this will be my topic tomorrow - stay tuned...

    Can't wait. Fed funds rate back up to 5.27% today.

  13. Bernanke can solve the problem, sort'a, by a deep discount in the Fed Funds rate.

    The problem will be the dumping of the USD. The stock market, instead of going up, could collapse as every foreigner will want money out of the US, before they realize they should be getting the equity free ride up.

    As the market appears about to collapse (break below 12800 and scream down from there) over the next 3 days, getting started towards a rather quick move towards 11000 over the next 2 - 3 weeks, I think that Bernanke's action will be the action that stops the decline below 10000.

    The bounce back up will be stupendous as well.

    This is my understanding based on the finally easy to read DJIA (for just a short window of time). It's party time for the ghouls.

    BB can wait for the market crash, before his talk in 1 -2 weeks, and then drop the rate, as the foreigners will have taken the economic hit and probably sold lots of stock, for dollars.

    There are plenty of foreigners who are parked in USD because they're hiding profits from their local governments. They're gonna learn the lesson... we're a paper tiger and they got stuck with their paper.

    hellacious, lookin fwd to readin' what it's gonna look like.

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