By Thomas E. Heath
Washington Post Staff Writer
Friday, June 29, 2007

The past five years have become known as the "golden age of private equity," with easy credit fueling multibillion-dollar corporate takeovers, a seemingly endless stream of old-line U.S. companies like Chrysler and Burger King being scooped up by private-equity firms, and the minting of a cadre of billionaire dealmakers.

But there are signs over the past week that the halcyon days may be passing.

On Tuesday, investors spurned $3.6 billion in bonds and loans related to the buyout of U.S. Foodservice of Columbia, the nation's second-largest food distributor. On Wednesday, Catalyst Paper, a Canadian company, pulled a $200 million offering of junk bonds because of an "adverse" market.

Carlyle Group of the District yesterday reduced the size of a planned initial public offering for a fund that invests mostly in mortgage-backed securities, to $300 million from $400 million. The firm also cut the share price to $19, from a range of $20 to $22. A Carlyle spokesman cited "headwinds" in the credit and debt markets as a reason for the retreat.

Billionaire corporate raider Carl C. Icahn gave his pronouncement: private equity's run-up was over. "For years, private equity has had a walk in the park," Icahn said at a New York financial conference Wednesday. "It's peaked. But, I don't mean these guys won't make money."

Private equity, headed by such giants as Carlyle, Blackstone Group, Texas Pacific Group, Madison Dearborn Partners and Kohlberg Kravis Roberts, which is the firm behind U.S. Foodservice, has spent more than $900 billion so far this year to buy companies. Driven by low interest rates, generous credit conditions from lenders and an inexhaustible investor demand for high-risk, high-reward deals, the big private-equity firms have prospered.

They buy public and private firms, hold them for months or years, during which they try to make them more efficient while sometimes piling them with debt. Then the private-equity firms try to sell the companies for a big profit either to another buyer or to investors through a public stock offering.

The firms typically disburse the gains to their investors and themselves after a few years. The formula has worked, creating huge wealth for its few participants and above-market returns for the pension funds and institutions that typically invest in these firms.

Now there is a general recognition that debt financing has been too cheap and the terms of repayment too loose, sources familiar with lending practices on Wall Street said. That has caused some risky investments to be funded too easily, as in the subprime mortgage market. Lenders are pulling back from those deals now but also demanding higher interest rates and stricter repayment clauses for fundamentally sound transactions, such as the proposed purchase of U.S. Foodservice, they said.

Investors and lenders have become jittery in the past few months as defaults on risky mortgages have increased, leading to concerns that the losses could spread through the housing market and upset the rest of the economy. That has not happened so far, although Bear Stearns offered $1.6 billion to rescue one of its hedge funds, sending some tremors that may have given pause to investors reconsidering risky offerings.

"We're getting to the end of the era when you could just write a big check at a large multiple with the aid of cheap financing and ride a big surf into the beach," said Frederic V. Malek, chairman of Thayer Capital, a private-equity group in the District. "But there will always be a robust market for private-equity that results in increasing the growth and improving the efficiencies of companies, and thus enhancing the value of those businesses."

Donald B. Marron, chief executive and founder of Lightyear Capital, a private-equity firm that provides capital to financial-services companies, said the era of private-equity is not over.

"Lenders watch carefully what's happening," said Marron, former chairman of PaineWebber Group. "You are seeing right now the beginning of a realistic assessment which will put the market back in balance."

Investors are also concerned that the debt private-equity firms have layered on their acquisitions and the big prices that they have paid may present too much risk, especially if a credit squeeze is looming that will raise the cost of borrowing money.

John K. Delanaey, chairman and chief executive of CapitalSource of Chevy Chase, which is active in credit markets, said credit was not drying up, but was making a healthy adjustment.

"We are seeing an adjustment in terms and overall risk appetite among debt investors," said Delaney, whose company makes business loans from $20 million to $250 million. "Good companies with solid capital structures will still be financed, which will allow buyouts to continue, but overall leverage and purchase multiples will probably adjust slightly. The past few years have seen a big risk transfer from private-equity firms to banks. . . .This should all lead to a healthier environment."

Carlyle's managing director and co-founder, William E. Conway Jr., cautioned in an internal memorandum in January that the highly liquid credit markets would not last forever and that the firm should pull back from high-risk deals."

"Frankly, there is so much liquidity in the world financial system, that lenders are making very risky credit decisions. This debt has enabled us to do transactions that were previously unimaginable," Conway wrote.

There are other signs that the rose may be fading. Blackstone, which completed an IPO of its management partnership last week, raising $4.1 billion, has seen its shares fall to less than the $31 offering price. Blackstone closed yesterday at $29.69 a share. Several other private-equity firms, including Carlyle, had been expected to follow Blackstone's path toward an IPO.

Staff writer Kathleen Day contributed to this report.