Bankruptcy Filings Settling In

March 31, 2008

It’s only four months into 2008 and the nation’s largest law firms have already concluded that bankruptcy will be a big growth area in the coming year, according to a recent survey by Robert Half Legal.

While that is not an entirely surprising finding it should be noted that the bloodletting or restructuring of overleveraged companies, primarily those that underwent private equity transactions in the last couple years, has hardly begun. By all accounts the buyout industry, which orchestrated a virtual tsunami of highly leveraged M&A transactions in 2006 and 2007, is facing a restructuring wave of pandemic proportions if recent corporate credit agency actions and court proceedings offer an indication.

In other words there will be a lot of blood.

Moody’s has issued ratings affirmations and downgrades on companies with liquidity concerns or facing tough economic prospects. Of course, companies that have taken in private equity dollars over the last few years are in the crosshairs of the ratings agencies. Moody’s downgraded Simmons, the mattress company owned by THL, formerly Thomas H. Lee Partners, for instance, because it faced the discomforting prospect of “soft discretionary consumer” spending coupled with rising raw material costs and limited cushion in its financial covenants. Separately, Moody’s noted that while GTCR Golder Rauner-backed Prestige Brands’ financial and operating performance remains on track with relatively strong credit metrics, its tight covenant compliance, as well as the potential elimination of the revolver, may require the company to renegotiate with its lenders. These companies are better off than some other private equity portfolio companies.

Take, for example, Wickes Furniture, Lillian Vernon and Sharper Image, three portfolio companies of Boca Raton, Fla.-based Sun Capital Partners which have filed for bankruptcy protection. It’s a given that a slowing economy only portends more bankruptcies and out of court restructurings for highly leveraged businesses. And, middle-market companies, a big area of investment for large and mid-sized private equity buyers, aren’t any more immune from adverse economic circumstances than their large cap counterparts.

If there’s a bright spot in the whole mess, and there is one, it’s for the various restructuring and law firms that advise the banks, specialty lenders and private equity investors. For better or worse, what is one constituency’s corporate version of carrion is another’s feast.