The strategic buyers’ return to the M&A market won’t exactly be greeted with cheers from the private equity community. With deep pockets and a directive from shareholders to show growth, their presence at the auction block generates about as much goodwill from the LBO sponsors as George Steinbrenner’s arrival at the winter meetings.
However, because strategic buyers are showing signs of ramping up their M&A activity, for the buyout players that are looking to sell a company, their arrival couldn’t have come soon enough.
Jim Coulter, co-founder of Texas Pacific Group, points to the absence of the corporate buyer as the primary reason LBO shops have been so active. “The pendulum has swung away from the strategics. There has been some activity recently. But compared to what we saw through the 90s, there has been much less activity,” he said.
However, others believe the pendulum is about to swing back, which would help LBO shops unload some of their past investments.
Jamie Singleton, president of Cypress Group, said, “Strategic buyers are just beginning to come back. We’ve had a year where the stock market was up for the first time in three years, and valuations are a little better if you’re selling, so the conditions for exits are naturally better.”
Mark Mealy, head of M&A with Wachovia Securities, added, “The public market is no longer penalizing companies for making acquisitions.”
The exit market has been largely nonexistent in recent years. The corporations have been going through a prolonged restructuring period and the IPO market essentially desiccated after the bubble burst. In 2003 only 16 buyout-backed companies made it to the public marketplace (See chart on page 47). During this period, buyout shops have primarily had to rely on sales to other private equity firms or a recapitalization in order to find liquidity.
However, pros think that times are changing. Erik Hirsch, chief investment officer with Hamilton Lane, said, “The exit market has definitely been picking up, and for some firms the exits have been great. People in this market are always happy to get money back, and we’d view the flow of capital back to us as really positive.”
While neither the IPO market nor the strategic interest could be categorized as heady, each exit route has shown enough promise to keep firms optimistic going into 2004. Among the corporate exits last year were Kenner & Co.’s $950 million sale of Therma Tru to Fortune Brands, One Equity Partners’ $575 million sale of AbilityOne Products to Patterson Dental, and Rockwell Collins’ acquisition of Arlington Capital Partners’ NLX Corp., in a roughly $125 million deal. Kelso & Co.’s sale of Peebles to Stage Stores and Crescent Capital Investments sale of Medifax-EDISM to WebMD also generated a lot of press last year.
The strategic interest is not unrelated to the gains made in the stock market in 2003. With the Dow breaching the 10,000 barrier and the Nasdaq flirting with 2,000, public companies suddenly find themselves entering 2004 flush with more capital than they’ve seen in a long time, and after trimming assets these past few years, the larger businesses appear ready to start adding on again.
And with the public market gains, the IPO picture has shown signs of clearing as well. In the second half of 2003 there were grumblings of activity that had been absent last year. Among the more notable offerings WL Ross & Co. floated its International Steel Group platform in a $462 million IPO, while Kohlberg Kravis Roberts & Co. and Teachers’ Merchant Bank brought their Canadian yellow pages portfolio company public on the Toronto Stock Exchange as an Income Trust. Other IPOs in 2003 include Berkshire Partners’ floatation of Carter’s Inc., Clayton, Dubilier & Rice’s IPO of SIRVA and Fox Paine & Co.’s United National Group floatation.
“People tend to forget. Something like Google will go public and everybody will be clamoring for an IPO again. The further we get from the pain of the IPO crash, the more we’ll see people look to delve back into it,” said Coulter.
Secondaries Second to None
And even while the strategic sale and the IPO exit avenues are finally starting to open up, buyout firms will also likely continue to seek out sales to fellow LBO shops. In 2003, there were over 40 sponsor-to-sponsor secondary sales, including Citigroup Venture Capital’s sale of Great Lakes Dredge & Dock to Madison Dearborn Partners, Fenway Partners’ exit of Simmons Co. in a sale to Thomas H. Lee Partners and Odyssey Investment Partners’ sale of TransDigm to Warburg Pincus.
With an estimated total of $99.5 billion in capital overhang, according to Thomson Venture Economics, most believe buyout shops will continue to provide a source through which to exit. And the misgivings about buying another LBO shop’s property has by and large dissipated, especially considering that with the financing market where it is, LBO shops buying today can usually add substantially to the debt and decrease the leverage costs.
“In 2001 and 2003 there were not a lot of liquidity events,” Mealy said. “With the improvement in the economy, what we’re seeing now is that a lot of these portfolio companies are starting to look for sales.”
Hamilton James, vice chairman of The Blackstone Group, agrees: “The stock market has rebounded, and you have a lot of buyout funds that are coming into their investment period, so there should be quite a few liquidations ahead.” And while James believes the strategic activity will “pick up steam” in 2004, he said, “I’d like one more year with those guys on the sideline. Let us put to work another $2.5 billion or so, then, as far as we concerned, they can come back in droves.”