In what could be a first for the LBO market, add-on deals represented more than half of all control-stake transactions closed in the last fiscal quarter; a strong indication that buyout firms are more interested in shoring up their portfolios than growing them in this time of distress.
The market has also been colored by a growing presence of turnaround and bankruptcy plays, as well as a continued shrinkage of deal size. With little to no leverage available, firms like The
Sure, buyout pros raised more than $600 billion in dry powder in the last two years and the industry today dwarfs what it was during the last recession. But those factors don’t appear to be enough to stoke deal flow under current conditions. Indeed, from the time the credit crunch reared its head in mid-2007 to the close of 2009’s first quarter, the U.S. leveraged buyout market has statistically reverted back nearly seven full years to where activity languished in the thick of the previous downturn.
“Anything needing leverage is difficult to get done,” said Ned Valentine, a managing director at middle-market investment bank Harris Williams & Co.
Regardless of how much the LBO arena has grown since Q1 2002, deal pros in the first three months of 2009 only barely outpaced the $4 billion in disclosed LBO spending from that former recessionary period, according to Thomson Reuters, publisher of Buyouts.
In Q1 2009, U.S. deal pros closed 120 control-stake deals for a disclosed total of $5 billion. The deal count total and disclosed value represent respective declines of 15 percent and 29.6 percent compared to Q4 2008’s 142 closed deals and disclosed value of $7.1 billion. Year-over-year, the contrast is even more startling with the deal count down 52.3 percent and disclosed deal value down 92.1 percent compared to Q1 2008’s 253 closed deals for a disclosed $63.3 billion, according to Thomson Reuters.
Aside from the lack of leverage, buyout pros today have no shortage of distractions from their traditional tasks of finding and closing control-stake deals. The decimated stock market is feeding a growing appetite among general partners for minority-stake and PIPE transactions. Meantime, ailing portfolio companies are coaxing some deal pros to spend their money on equity cures, while distressed prices on the loan secondary market have paved the way to a rash of debt buybacks. In the background is a mass of limited partners who, given the lack of distributions coming their way, are likely content not to be inundated with too many capital calls.
Regardless of the reasons for the slowdown, the consequences could be far-reaching. With so much overhang in the market, the reduction in closed deals will do nothing to diminish questions of whether firms raised too much money or whether some should continue to cut back on fund sizes going forward. Additionally, LPs might be less likely to back new funds if they believe their money will remain stagnant while GPs collect management fees.
Indicative of the times is the fact that the largest control-stake deal to in the first quarter was the $1.3 billion bankruptcy acquisition of IndyMac Bancorp Inc. by a
Industry-wise, however, there has been little change in terms of the most popular silos for LBO investing. The four most popular sectors of Q1 2009—industrials (26 deals), consumer products and services (17), materials (14), and high technology (14)—are the same four that topped the charts in Q4 2008, though in a different order, according to Thomson Reuters.
The focus today clearly isn’t on deal size. Rather, the impetus is on how the next deal will strengthen the ones that were already made. “Private equity groups are aggressively pursuing add-on acquisitions to reshape their companies to be more strategic when they come out of the other side of this [downturn],” said Eric Malchow, a managing director at middle market investment bank Lincoln International.
Indeed, add-on acquisitions outpaced traditional platform acquisitions for the first time since Buyouts began tracking such information in 2003. Roughly 51 percent of all closed deals in the quarter ended March 31, 2009 were bolt-on acquisitions to existing portfolio companies. That’s up from 33.8 percent in Q4 2008 and 39.9 percent in Q1 2008, according to Thomson Reuters.
Particularly active on the add-on front were Boston’s
Meanwhile, as more and more companies end up insolvent buyout pros are picking up a larger portion of their deals through bankruptcy processes. Approximately 5 percent of deals closed last quarter were acquisitions of companies out of bankruptcy situations. Such acquisitions made up less than 1 percent of the closed deal totals for every quarter last year, according to Thomson Reuters.
Generally, however, a number of firms that were actively closing deals throughout 2008 have either drastically slashed their investment pace or simply stepped out of the control-stake deal market at all in the first quarter. New York-based Blackstone Group, which closed 17 deals last year; and Boston-based
“When there are so few transactions out there, it’s a sign that there is still a gap between sellers’ expectations and what buyers are willing to pay,” said Richard Dresdale, co-founder and managing director at
A New Cast Of Characters
With relatively no leverage available, the mega firms have all but ceased to have any impact in the deal market whatsoever. Absent from the LBO arena last quarter were firms including The Blackstone Group,
The turnaround cadre, meanwhile, was well represented as firms like
A number of turnaround investors were cautious last year of stepping into the market too soon, and investing in a company whose value was still falling. On top of that, a number of business owners were frozen in a state of shock in the latter half of 2008 due to the quickly deteriorating quality of their businesses. But things today have changed as a seemingly endless precession of companies with over-leveraged balance sheets and a need for operational change head closer to default.
KPS Capital closed three deals in Q1 2009, the most recent being its March 26 acquisition of certain domestic and international assets of bankrupt luxury tableware provider Waterford Wedgwood Plc.
Monomoy Capital, meanwhile, took advantage of the distress in the market to build-up its existing portfolio companies. During the last quarter, the turnaround shop closed add-ons for its plastic injection and extrusion company Fortis Plastics LLC and its auto component platform Compass Automotive Group Inc.
“We may be entering a season of capitulation,” said Stephen Presser, a partner at Monomoy Capital. “We’re seeing fewer people in denial and more sellers and stake holders accepting a new market reality for the next 12 to 18 months that includes the inevitability of change-of-control transactions.”
Perhaps to nobody’s surprise, buyout-backed companies are among those looking for new ownership. “We are seeing a number of PE sponsored deals that just are not going to make through this cycle,” Presser said.
Typically, these are eight or nine-year-old investments from early generation funds that are now out of capital, Presser said. For example, say a firm is currently investing from its third fund but still owns an underperforming company its first fund. Because Fund I has no more dry powder, and because the firm has newer investments to worry about, it’s simply more efficient for the firm to jettison the older, underperforming investment (potentially at a loss) rather than attempt somehow to save it. “We’re seeing a lot of firms letting those companies go,” Presser said.
Harris Williams’s Valentine agrees. He told Buyouts that his firm is “working with multiple companies that fit that profile today.” Moreover, Valentine said his firm has been approached by a number of troubled sponsor-backed companies that are being forced by their bank lending groups into a sale.
“You’re seeing more of that, and you are going to see a lot more of it over the next 12 to 18 months, particularly absent any improvement in the economy,” Valentine said.