Credit Woes Widen
The $8 billion buyout of audio-equipment maker Harman International Industries collapsed yesterday, the first major private-equity deal to unravel since the current credit turmoil began and a sobering sign for other big takeovers in the works.
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It also left analysts and others wondering what effect the collapse would have on buyout king Henry Kravis and on Goldman Sachs, the world's largest investment bank. Any time a company reneges on an agreement, it puts its reputation at risk. It may find companies reluctant to do deals in the future, said several analysts who follow mergers and acquisitions.
The breakup could set a precedent for other private-equity firms to get out of acquisitions that have become less profitable because of the rising cost of financing big buyouts, the analysts said.
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To get out of their deal, KKR and Goldman Sachs are citing a "material adverse change" clause, which is included in virtually every buyout agreement but is rarely invoked. It defines what changes would significantly alter the value of a company that would allow its buyers to back out.
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Invoking this clause is often used as a negotiating tactic by buyers seeking a lower price. Since 2003, no deal has been canceled because of a material adverse change clause, according to the research firm FactSet MergerMetrics.
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A legal battle over the Harman deal could effect other buyouts, such as the $25 billion acquisition of student loan giant Sallie Mae. Its private-equity buyer, J.C. Flowers, has talked about using the material change clause to force the company to consider a lower price. On Thursday, Sallie Mae released a statement saying it disagreed with J.C. Flowers on the matter.
None of this was unanticipated. The drop in the Fed rate was a stop-gap measure, but the money supply will remain tight. This still needs to work itself out. The losses in the sub-prime market have done major damage to mortgage lenders, but thanks to the financial instruments used to sell off those mortgages once they were made, nearly every bank and fund is feeling the pinch. The run on Northern Rock in Britain has led the banks there to be asked to proactively disclose their exposure. Confidence is down, and the perceived risk of lending is higher, which makes borrowing more expensive and deals based on borrowing less attractive.
And the real fun, as fester reminds us, is that this whole mess is really only just getting started.
