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The Tyranny of Other People’s Money

4/4/07

A recent Financier Worldwide magazine piece by David Nicholson asserts that today “most middle-market deals are able to get leverage at about 5x [EBITDA]." The article goes on to say that “some aggressive lenders are offering as much as 7x.”

The easy availability of such credit, much of it “covenant lite”, is a major factor in the new highs realized by sellers. Some high-quality mid-market companies are seeing sale values of 10x EBITDA with even mediocre ones snagging 8x. Of course, the average deal size has also inflated considerably: in the 1980’s, LBO transactions averaged $3.3B. Now they’re at nearly $18B. So the term “middle market” currently means a value range of between $500M and $3B.

With this background, when we read that Sam Zell will purchase the Chicago Tribune mostly with $12B in debt (coupled with the tax benefits of using an ESOP as the transaction vehicle), it ought to make a lot of people nervous. That amount of debt is 10 times the Tribune’s annual cash flow. A Barclays Capital analyst opines that “It is possible that [the] Tribune is leveraged higher than the total assets of the company after taxes." Add to this the fact that -- as the newspaper business reels from Internet and myriad specialty media assaults -- the Tribune’s recent financial performance has faltered.

Of course, the magic of such massive quantities of debt is that the sellers get a windfall value while Zell himself has very little exposure, about $325M to be precise. If all his financial machinations work, he makes a lot of money. If it doesn’t, well he hasn’t lost much. But if the Tribune is crushed under its huge debt burden, the lenders take it in the shorts (and respond by raising the cost of credit for everybody), and Chicago loses a major employer.

What’s our take-away from all this? If you’re contemplating selling your company, do it now: you’re unlikely to see higher values in your lifetime. And with luck the lenders may get their money back.


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