Moody's warns about private equity buyout risks Thu Jul 5, 2007 3:38PM EDT NEW YORK, July 5 (Reuters) - As private equity firms pile more debt on U.S. companies, their commitments to eventually de-leverage these businesses may not be fulfilled, Moody's Investors Service warned in a new report. Buyouts by private equity firms, also known as leveraged buyouts, accounted for about 18 percent of all new junk-rated bond sales at the beginning of this year, up from about 5 percent between 2003 and 2004, Moody's said. In a leveraged buyout, private equity firms increase debt at a target firm substantially, using mostly debt proceeds and a small portion of their own equity to fund the acquisition. In the past, private equity firms were expected to recoup their investment by taking a company public again or selling it, but this is no longer the case, Moody's said. When the market for shares has been weak or credit easy to get, private equity firms have returned capital to themselves with special dividends rather than sell shares in an initial public offering, Moody's said. In some recent LBOs, private equity firms have cashed out within 12 to 18 months of an acquisition, effectively pulling out all of their initial investment by paying themselves dividends, Moody's said. "It seems reasonable to assume that firms that have already made an attractive return on their investment may consider increasing the financial risk associated with that issuer," Moody's said. In theory, the added leverage in an LBO is supposed to impose discipline on the acquired company, compelling it to cut costs and improve operations. While such benefits may occur, "the ultimate beneficiary of these advantages may be the private equity firm," Moody's said. Creditors, on the other hand, "are not participating in the potential upside available to private equity firms or original shareholders," the agency said. With debt remaining high, the future of many target firms will likely hinge on a stable economy and welcoming credit markets, as many deals will need to be refinanced in coming years, Moody's said. More buyouts are also relying exclusively on bank financing, as opposed to fixed-rate bonds, so they will be vulnerable to higher borrowing costs as interest rates inevitably rise, Moody's said.