Return of Staple Financing for LBO Deals

It is quite shocking to me that less than one year after the complete demise of the credit markets, investment banks are reportedly offering aggressive "staple" financing deals to faciliate a new round of LBOs.  As reported by the Wall Street Journal ("Equity Firms Cheer the Return of Staple Financing; Critics Don't"), Interactive Data Corp, Michael Foods, Hillman Group, and Bresnan Communications have all received staple financing packages in the 5.5x-6.0x debt/EBITDA range.  While all four are quality companies that should attract ample interest from prospective investors, the indicative leverage levels harkens back to the 2006/2007 timeframe when purchase multiples were driven to unsustainable valuations due to leverage provided by the selling investment banks.   Admittedly, 6x is less than the 7.5-8x that existed at the absolute peak of the LBO boom, but still represents a level well north of historical averages (~4.5-5x).

As I have commented in past posts, I firmly believe that the credit markets are far more overvalued than the equity markets.  The compression we saw in spreads last year was due to robust inflows into credit and a lack of new incremental supply (i.e. most of the new issuance volume was due to refinancing).  With several large LBOs announced over the last few weeks, including the four mentioned above, the supply part of the equation may finally be tested as we progress through 2010.  Should inflows begin to moderate, the technicals of this new supply could force a widening in spreads, particularly if the Fed begins to tighten (though probably unlikely for the remainder of 2010).