FOR the past five years big business has been hijacked by a crowd of smart financiers who, backed by cheap money, have bought and sold companies at their whim.

But as the events of the past week have shown, and as my colleagues explain in The Party's Over (see related link in panel, left), the days of easy credit are over. The world’s big banks, which have made billions fuelling this boom, have called a halt. It has happened in the space of only a few weeks and the impact has hit global equity markets hard as companies whose shares had fizzed up on the back of takeover speculation have seen those gains wiped off.

But the big question is whether we are just seeing a repricing of risk or whether liquidity is being withdrawn. If it is the former, the consequences are not so severe. It simply blows away the ability of private equity to pay prices well beyond what a trade buyer could justify.

In all the madness of the past five years it is easy to forget that business is about long-term revenue growth, about operational skills, development in people and research and development.

The importance of all this has been sidelined in the orgy of leveraged buyouts. If risk is simply being repriced it will lead to a new and more sober era where banks will become more cautious about their exposure to leveraged buyouts. Deals will still get done but with more equity and less debt.

The month of August is never a good one to gauge the correct mood of the City. Most leading practitioners are on holiday. It will take at least two months before we have a sense of how severe the outlook is.

In the interim the refinancing market is closed. However, if liquidity is withdrawn the consequences are much more severe. If banks stop lending to hedge funds and hedge funds sell their loss-making positions, a sharper market downturn could become self fulfilling. We have had market wobbles before in the past two years and popped out the other side. I still believe that to be the case, but the world will be more sober.

At the moment the shock in the credit market is a bank problem. It’s a big one but it is confined. The underlying businesses that their loans are secured against, like Alliance Boots, are still performing well. Corporate defaults are low and the wider economy is still powering ahead. As we will see this week when Centrica reports its figures, the bulk of UK corporates are still doing well, they are generating cash and the bulk of our big-cap stocks remain underleveraged.

If problems do appear it will be in some of those highly leveraged deals. How, for example, could Blackstone justify paying a 30% premium to acquire Hilton, the international hotelier? The 18% fall in Blackstone’s shares since it floated says it all. This will be where some of the cracks will come and the pain will be felt by the banks that have financed the bulk of these deals with 90% debt and Ebitda multiples that were eyewatering.

Smiths get-together

ONE company that believes it is vulnerable to a takeover is Smith & Nephew, the UK medical devices maker, which recently lost out to a private-equity consortium to acquire Biomet, the American maker of orthopedic implants.

S&N, which is capitalised at £5.3 billion, believes it is a sitting duck. Sir Chris O’Donnell, who was the principal driver behind the group’s success, has just left and the group has a portfolio of attractive assets. One deal being discussed is a clever tie-up between Smith & Nephew and Smiths. The latter has just hived off its aerospace business to General Electric for $4.8 billion and as a result will now focus on its medical devices business. Smiths is capitalised at £3.9 billion and would make a good fit with S&N. Now private equity is out of the frame this could be an ideal window to pull off such an ambitious plan.

Beijing bargain

WIN or lose his battle for ABN, the Dutch bank, John Varley, chief executive of Barclays, has pulled off a great deal bringing in its new shareholder, the China Development Bank. I accept there are concerns about having a paid-up member of the Communist party on the Barclays board, the CDB’s investment in infrastructure projects in Zimbabwe and the bank being part of China’s state ownership.

But if this deal works it could produce profits of at least £500m, a business bigger that Barclaycard, within three years. Varley wants Asia and China to account for 25% of the group’s revenue. And unlike his rivals, which have acquired stakes in Chinese banks, he has done this with minimal outlay.

He is prepared to accept the reputational risk. CDB, which is initially acquiring a $3 billion stake in Barclays, wants to spread its wings and Varley is betting that it will not want to do anything to jeopardise its standing. Because Barclays’ bid for ABN is still largely financed with paper, it needs its shares to be close to 800p. But along with the rest of the banking sector its share price got spanked last week, closing at 682p.

ABN would be a great fit for Barclays, but even without it the CDB deal furthers Varley’s ambition to boost the bank’s overseas earnings to 75%. Barclays has a proven record of organic growth. Just look at Barclays Capital.

There are those who question whether Varley will win ABN but it would be wrong to bet against China. This is a low-risk ticket into one of the most exciting markets in the world.

john.waples@sunday-times.co.uk

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