Investors End Deal To Buy Sallie Mae
Credit Crisis, Subsidy Losses Cited as Factors

By David Cho and Thomas Heath
Washington Post Staff Writers
Thursday, September 27, 2007

One of the largest private takeovers in history -- the $25.3 billion buyout for college loan giant Sallie Mae -- unraveled yesterday after its buyers balked at the price, citing turmoil in the credit markets and federal legislation to cut subsidies to student lenders.

The buyers, headed by fund manager J.C. Flowers, left open the possibility of acquiring Sallie Mae at a lower price. Sallie Mae vowed, however, that it would fight to keep the deal intact "to the fullest extent permitted by law."

If it fails completely, the deal for the Reston lender, known formally as SLM Corp., would be the biggest casualty so far in a trend of mega-buyouts that were negotiated in happier times only months ago, when money was easier to borrow. Last week, Harman International, which is based in the District, saw its $8 billion agreement come apart when the would-be buyers walked away.

"Several deals have collapsed under their own weight. There will be more," said Frederic V. Malek, chairman of Thayer Capital, a private-equity firm in the District.

When it was announced in April, the Sallie Mae buyout was hailed on Wall Street as a watershed for private equity, which had never been able to acquire a major financial firm. Some student loan specialists denounced the deal as evidence of just how large a profit machine Sallie had become providing government-backed loans to cash-strapped students, and they worried that the sale price would lead dealmakers to squeeze borrowers.

The buyers included two of Sallie's largest competitors, Bank of America and J.P. Morgan Chase, and they claimed the deal would have increased the availability of student loans at a lower cost. Others worried that the deal was anticompetitive and would do just the opposite.

The buyers originally agreed to pay Sallie Mae $900 million if they walked away from the deal, one of the largest breakup fees ever. Instead, they now are invoking an "escape" clause that would allow them to cancel the purchase without paying a dime, which Sallie Mae says it will fight in court.

Sallie Mae's stock dropped almost 10 percent, to $41.73, late in the afternoon after news broke that the buyout was off. The stock quickly recovered to close down 3 percent, at $45.01, as investors speculated that a new deal could be negotiated. After hours, the stock rose about 5 percent to $47.30. Sallie Mae had agreed to sell itself for $60 a share.

Sallie Mae has been guided the past decade by Albert L. Lord, who took over the company in 1997 after a nasty proxy fight and threw out management.

Lord engineered Sallie Mae's transformation from a government-sponsored enterprise to a private business, making himself and other executives among the most highly paid business leaders in the Washington area. In 2005, when he stepped down as chief executive, Lord became wealthy enough to build his own 244-acre golf course outside Washington and to mount a serious, though unsuccessful, bid to buy the Washington Nationals baseball team.

The "winds of politics" were blowing against Sallie Mae, and Lord said in an April interview that he expected them to blow harder. Politicians were taking aim at federal subsidies for Sallie Mae and other lenders, accusing them of getting rich from government programs meant to aid students. Lord said he sought the buyout partly because "I didn't see our share price rebounding anytime soon."

Lord's options and stock awards would have been cashed out at a gain of $224.9 million.

Peter Fitzgerald, longtime banker and former U.S. senator who partnered with Lord in the bid for the Nationals, said Lord would likely fight hard to keep the deal alive.

"He is a real scrappy fighter, very smart," Fitzgerald said. "Nobody is going to be able to push him around without getting a fight back."

Talks between the two sides have turned nasty.

The buyers have "tried to keep the temperature down," said a person familiar with their thinking who spoke on condition of anonymity because of the private nature of the discussions. But many of the negotiations were "acerbic" and little got done, the source said. The sides have not been talking actively in recent weeks.

"There's a lot of hardball going on," said another person familiar with Sallie Mae's thinking. "But it's in everyone's interest to get a deal done. I'm bullish a deal is going to get done."

The buyers are citing a "material adverse change" clause, which is included in nearly every buyout agreement but rarely invoked. It defines what changes that significantly alter the value of a company would allow its buyers to back out.

Flowers yesterday told Sallie Mae that changes in credit markets, which raises the cost of financing the buyout as well as college loan legislation that President Bush is expected to sign today, triggered this clause, giving it the right to get out of the deal. The College Cost Reduction and Access Act cuts subsidies to lenders while increasing the maximum size of Pell Grants for low-income students and cutting rates on subsidized student loans.

"We have told representatives of the Sallie Mae Board that we are open to discussing a revision of the transaction that reflects this new environment," the group said.

Sallie Mae contends the subsidy cuts are not enough to trigger the escape clause.

Invoking the material adverse change clause is often used as a negotiating tactic by buyers seeking a lower price, several private-equity analysts said. Since 2003, no deal has been canceled because of such a clause, the research firm FactSet MergerMetrics said.

The buyout of Sallie Mae, the 11th largest in history, was negotiated when the credit markets were booming and financing big deals was easier. At the time, other related stocks, such as the Bank of America and Student Loan Corp., rose on the news as traders speculated the Sallie acquisition would lead to a frenzy of new acquisitions in the financial sector.

That never happened. And a credit crunch in August shook confidence in the financial system, making money far more expensive to borrow.

That has left many private buyers feeling remorse for agreeing to pay high prices for companies. Several private-equity firms are fighting to get out of major deals or renegotiate the price. Carlyle Group of the District and two other private-equity firms, for example, recently got the struggling retailer Home Depot to reduce the price of its wholesale business by $1.8 billion.

While buyouts may not stop altogether, the Sallie Mae fight is demonstrating that this era of the mega-deal has all but ended, several analysts said.

"We haven't seen deals anywhere near the deals we saw in the spring," said Richard J. Peterson, director of capital markets for Thomson Financial. "For now, the time of the big deal is taking an extended vacation."

Staff writer David S. Hilzenrath and staff researcher Richard Drezen contributed to this report.

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