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Giant debt-backed mergers haunt Wall St.

By Guy HalversonStaff writer of The Christian Science Monitor / October 31, 1988



New York

Talk about Halloween! LBOs - leveraged buyouts - and mergers have suddenly become the bogymen of Wall Street. ``The push towards giant mergers, and certainly towards LBOs, is worrisome,'' says Leo Grohowski, director of equity portfolio management at Marinvest Inc. here. ``Of the 18 percent gain in the stock market since last year at this time, about one-third has been related to mergers and LBOs.''

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Mr. Grohowski oversees about $750 million in equity portfolios at Marinvest, an outgrowth of the Institutional Asset Management Group at Marine Midland Bank. If there were to be a market correction at some point down the road - and he does not profess to see when or even if such a correction may occur - could that correction be as much as a third of that 18 percent gain in the market?

Needless to say, Grohowski suggests, any major correction might send the Dow Jones industrial average tumbling well below the 2,100 range of recent weeks.

Indeed, takeover stocks dipped last week on growing concerns that the leveraged-buyout fervor could come to an abrupt end. LBOs are a way of taking a public company private. In effect, those seeking the takeover finance the package by mortgaging the acquired company's own assets. Debt is then retired in part by selling off components of the company.

The buyout fervor became so intense last week that even the Federal Reserve Board felt it necessary to comment. Fed chairman Alan Greenspan, who tends to be very measured in his public pronouncements, advised Congress that lawmakers should consider drafting legislation to limit the borrowing for corporate takeovers. He also warned commercial banks to ``make certain that they examine the prospects for LBO loans under a range of economic and financial circumstances.''

The Fed is clearly apprehensive that under a recession corporations and banks involved in LBOs could be adversely affected, in part because much of the LBO debt is particularly sensitive to interest rates.

One other unhappy partner in the current LBO fervor is the corporate industrial-bond market. LBOs tend to work against the corporate-bond market, because, as a company takes on massive additional debt, its credit rating often becomes downgraded. The value of existing bonds of that company then declines.

Prices for some corporate bonds have dropped recently because of the LBO and merger activity. Case in point: Kraft. The price of its 8 percent debenture bond due in 2004 fell after the announcement of its proposed restructuring. ``I'm concerned that [the LBO activity] may turn into a feeding frenzy,'' says James Drury, a vice-president and corporate bond analyst at Prudential-Bache Capital Funding.

``It used to be that large industrial firms were considered `bulletproof' because of their very size and day-to-day stability,'' Mr. Drury says. The companies, in other words, were just too big for some type of buyout.

``What's happened is that the perception of what is `bulletproof' has changed,'' he says. ``Large size, meaning $25 billion or more, doesn't give me as much comfort as it used to.

``Even so,'' he adds, commenting on the current buyout activity involving RJR Nabisco, ``if one LBO at $20 billion can get done, that doesn't mean that another one will get done.'' Drury says he is grateful for Mr. Greenspan's blunt warning.

Commercial banks have lent borrowers about $48 billion for leveraged buyouts this year, raising the total for all acquisition financing for the past two years to some $150 billion, according to an estimate by Oppenheimer & Co.

``We're recommending nothing but US Treasuries - 30-year Treasury bonds'' in the bond sector, says Charles Clough Jr., chief investment strategist at Merrill Lynch White Weld Capital Markets Group. Merrill Lynch's asset allocation guidelines currently call for a weighting of 40 percent stocks, 15 percent cash, and 45 percent bonds.

Mr. Clough believes the LBO phenomenon may be hitting its limits. Greenspan's warning ``was a shot across the bow, telling investors not to be profligate,'' Clough says. And then there was last week's withdrawal by underwriter First Boston Corporation of a $1.5 billion junk bond issue for a restructuring of Federated Department stores. For the week ending Oct. 28 the Dow closed down 33.61 points, at 2,149.89.