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Has Boots-KKR burst the private equity bubble?

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24th Jul 2007
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The debt-laden purchase of Alliance-Boots by KKR, coinciding with a sharp rise in investors’ risk premia, has become a test case for the ability of private equity - and its bankers - to withstand a liquidity squeeze.

Against a background of rising interest rates, the private equity acquisition of pharmacy and retail chain Alliance-Boots – the first of a FTSE-100 company – has become a test of creditor faith in highly leveraged acquisition. Banks acting for buyer KKR revealed last week they have overrun the deadline for placing £9bn of debt to finance the deal, having failed to find buyers at the chosen spread. Banks are reportedly bargaining for additional safeguards, including guarantees on interest cover, before subscribing on the offered terms. The timetable for completing the deal may now have to be extended.

Between negotiation of the sale price and issuance of the debt, the price being charged on this class of loan has risen by 1.0-1.5 basis points. A rising casualty count among US hedge funds – two run by Bear Stearns were this month reported as nonperforming – is the proximate cause of the crisis of confidence. Underlying it is the rise in EU interest rates, and the inability of the US to reduce its own – despite slower growth – because of a depreciation of the dollar that already threatens higher inflation. Last week’s Congressional report from Federal Reserve governor Ben Bernanke, with unspecific promises of second-half recovery, did nothing to revive the faith that big firms – especially those tuned mainly to consumer markets – will turn the profit to service the loans that some are now seeking.

Estimates of the amount of other commercial debt that big banks have underwritten and now cannot place go as high as £200bn. Securities market regulators and central bank chiefs have been warning throughout this year that a cluster of hedge fund failures, or an overextension of loans to private equity vehicles, could trigger a serious liquidity crisis, extending to solvency problems for some institutions. At the end of last week US regulators sealed a deal on the Basel II capital standards framework that will allow a reduction, over three years, of the reserves that larger banks are obliged to hold against their less risky loans. It may be too little, too late to offset the increased provision they need against riskier ones, unless the nerves frayed by present sub-prime loan deterioration are quickly repaired.

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