A leveraged buyout of this size will test the banking industry’s capacity to orchestrate and allocate vast amounts of capital on a global scale. It is also a big gamble for lead underwriter JPMorgan Chase & Co, which is putting up US$20 billion of financing — the biggest debt commitment ever by a single lender for a leveraged buyout (LBO). The bank stands to cement its role as market leader if it pays off, or tear a hole in its balance sheet if it goes wrong.
Here’s how these deals are supposed to work for investors with the risk appetite to dive in, and what, besides its sheer scale, makes this one so important.
What’s the point of leveraged buyouts?
Similar to a consumer acquiring a house or a car, a leveraged buyout enables you to purchase a company with financing secured against the asset being acquired. For the buyer, raising debt to fund a takeover tends to be cheaper than using their own money. That’s because credit investors generally assume less risk — and accept limits on returns — compared with equity investors, who could theoretically lose their entire investment if the target company implodes.
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As a general rule, leveraged debt costs around 5.5%, whereas private equity firms typically target returns of 20%. LBOs, as they are known, tend to flourish during periods when debt is cheap. Even though the decade of rock-bottom interest rates is over, it is still cheaper to fund a takeover with debt rather than equity.
Using borrowed money to make investments amplifies returns as it allows the buyer to control the acquired asset with a smaller amount of its own capital. So a subsequent rise in the business’s value produces a larger capital gain for its new owners. The converse is also true: A small decline in value can quickly wipe out a big share of the capital that serves as security on the debt. The company must maintain its profitability, as its cash flow will service the additional debt taken on as part of the buyout. The stronger the cash generation, the greater the borrowing the target can support at the outset.
How do leveraged buyouts usually work?
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They are often orchestrated by private equity firms whose owners are willing to make riskier investments to amplify returns. An LBO is financed initially by a syndicate of banks, which will slice up the debt and sell it on to all kinds of other investors such as hedge funds, insurance companies, pension funds and banks in exchange for a hefty fee.
LBOs are one of the most lucrative corners of investment banking when it all goes to plan. But a sudden change in either global credit markets or the acquired company’s performance can leave the banks stuck with the debt they were hoping to get rid of, languishing on their own balance sheets.
Why is the EA deal so crucial for Wall Street?
Because of the sheer amount of risky borrowing involved, it is a major win for traditional banks that face a growing challenge from the fast-growing, US$1.7 trillion private credit industry. Private credit is closer in culture to private equity and has snapped up a large number of LBO financing deals in recent years.
Notably, JPMorgan made the EA deal commitment through its more traditional leveraged-finance arm, rather than its new private credit business. The world’s biggest investment bank by revenue is expected to share the risk with rival firms to create a global syndicate of underwriters. Most major banks will want to participate, seeking a share of the fees and an opportunity to demonstrate the superiority of this funding route over private credit.
They still need to pull the deal off, and its unprecedented scale and complexity will test whether they have correctly judged potential demand in the wider investing community. The debt is expected to be rated single-B, or right in the middle of the junk debt spectrum.
What does the EA deal say about the state of credit markets?
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If a single investment bank is willing to underwrite $20 billion of junk debt on its own, it means JPMorgan CEO Jamie Dimon is feeling good about the leveraged finance market.
One reason for that optimism is expected demand from issuers of collateralised loan obligations — bundles of sub-investment grade loans packaged into bonds of varying levels of risk and reward. A flurry of recent CLO issuance is underpinning demand for debt deals and pushing junk borrowing costs to their lowest in years. Some 160 such funds were being set up as of early October, and they typically buy syndicated loans distributed by banks.
The debt eventually sold to investors will likely be a mix of high-yield bonds, which usually carry a fixed coupon, and leveraged loans that generally carry variable coupons. The cross-border, dual-currency offering is slated for the first quarter of 2026. By shunning private credit, it breaks with recent convention and challenges the notion that any mega-financing now requires tapping all sources of capital, including bank loans, bonds sold in capital markets and private lending.
Another positive signal is greater risk appetite among institutions in the Middle East, Asia and smaller European markets as a post-pandemic inflation and interest rate surge abates. These are seeking exposure to leveraged loans on a take-and-hold basis — effectively competing with CLOs for supply. Several of these banks are already vying to participate in the EA transaction. Although the approval process at such lenders can be slower than at credit funds, their substantial balance-sheet capacity could prove critical given the scale of the deal.
What are the risks for those involved?
If the credit market turns sour before the banks have had a chance to offload the debt, they could end up on the hook. Recent history offers a warning: The last big leveraged buyout — for Elon Musk’s US$44 billion acquisition of Twitter Inc in 2022 — was painful for many of the lenders that took part. One group led by Morgan Stanley was stuck with about US$13 billion of debt, and it took until this year for them to finally shift it off their balance sheets.
Credit markets are also reeling from two sudden corporate collapses that took investors by surprise. Auto-parts supplier First Brands Group filed for Chapter 11 bankruptcy at the end of September with liabilities of around US$10 billion, sending shock waves through hedge funds, private credit funds and banks with exposure to the company. That came shortly after Tricolor Holdings, a used-car seller and subprime lender, also filed for liquidation, leaving lenders facing potentially hundreds of millions of dollars of losses.
Market capacity has never been tested by a deal of this scale. Bankers close to the EA transaction estimate that investors could absorb around US$25 billion in dual-currency leveraged loans and high-yield bonds at most. In comparison, others put the figure closer to $15 billion.
Unlike issuers of private credit, banks must consider more than just filling an order book. They have to consider how the debt will trade after issuance. Selling investors all the debt they subscribe for can undermine demand in the secondary market, where investors who miss out the first time get another chance to acquire it. This could erode its present value. Conversely, if the paper rallies sharply after pricing, Silver Lake and EA’s other owners may feel they overpaid for the debt and that it was priced too generously. Striking the right balance is essential, as it can determine whether a transaction is viewed as a success or a misstep.
Who are the biggest potential winners from the LBO?
JPMorgan stands to gain the most by far. Jamie Dimon’s ability to commit to this deal underscores not only the strength of his personal relationships but also the firm’s willingness to go all-in when it truly believes in a transaction. The bank is known for taking a cautious approach to leveraged buyouts, at times stepping back from financing a buyout even when it was advising some of the parties involved — a move often viewed as taboo in leveraged finance. That restraint, however, spared it from costly missteps such as Twitter’s debt and the buyout of Wm Morrison Supermarkets.
Then there are the new owners of EA — Silver Lake, Affinity and the Saudi PIF.
How will they make the EA takeover pay off?
Private equity firms are looking for software assets that aren’t seen as likely to get disrupted by the rise of artificial intelligence — and gaming companies are among those.
EA, known for popular games such as Battlefield and EA Sports FC, ranks among the largest video-game companies in the US, alongside Roblox Corp, which is valued at around US$88 billion, and Take-Two Interactive Software Inc, publisher of the Grand Theft Auto series, which has a market capitalisation of US$47 billion.
The Saudis view ownership of EA as a catalyst for their ambition to transform the desert kingdom into a hub for gamers and a major global player in e-sports, where top gamers compete before large online audiences. So they see a soft-power payoff, as well as a financial one.
To some industry observers, the takeover suggests EA executives are looking for an exit because of concerns about the future of the US$178 billion video-game industry, which has struggled in recent years to find new avenues of growth. After a period of big spending on gaming throughout the 2010s and into 2020, when the Covid-19 pandemic boosted sales, growth has slowed significantly. Gamers now prefer sticking with old favourites over purchasing new titles, which can cost up to US$80. — Bloomberg Quicktake
