Why the prospective $70 billion buyout of Walgreens may signal the stock-market rally is about to end

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If investors ever needed a clear signal that this is the top of the market, they now have one.

Walgreens Boots Alliance shares surged Wednesday amid speculation that the U.S.-listed drugstore group has been considering a $70 billion take-private deal.

If private equity can pull it off, it would be the biggest leveraged buyout ever, dwarfing the $45 billion transaction in which energy group TXU was taken private in 2007, just a year before the financial crisis rocked global markets and prompted unprecedented intervention by global central banks.

Financing a buyout deal on the scale of a Walgreens deal today could be a big challenge.

For one, Walgreens WBA, +1.04% already has $15 billion in debt on its balance sheet. A potential bidder would need to add more leverage to fund the purchase. That would leave the drugstore chain particularly vulnerable when the credit cycle turns — which is looking increasingly likely.

Factor in a premium on the current stock-market valuation and the total cash needed becomes quite dizzying. All this at a time when risky corporate loans are rapidly piling up on Wall Street’s books.

The volume of leveraged loans has reached $3.4 trillion worldwide, according to estimates from the Bank of England. Credit quality has deteriorated, with most new leveraged loans being issued by companies that have high levels of debt as compared with their earnings.

Worse, the share of new leveraged loans with no maintenance covenants — requiring the borrower to maintain certain financial buffers such as a debt-to-Ebitda ratio, or earnings before interest, tax, depreciation and amortization, of less than five times — has tripled since 2007, the U.K. central bank said.

Banks are already struggling as investors steer clear of hefty private-equity debt packages.

Take Bain Capital’s $4 billion buyout of market-research firm Kantar in July. The U.S. private-equity firm lined up 11 banks to assemble a $3 billion debt package.

But after an underwhelming reaction from the market, the banks had to restructure the debt package to make it more palatable to investors. This included raising the pricing on the loans and tightening the covenants.



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