It’s the end of August in New York, and after a torrid summer exacerbated by the heating effects of La Nia everyone is looking forward to the cooler temperatures that will be brought by fall.
However, like the eagerly anticipated climate change caused by the cycle of the seasons, another cycle has come full circle. Buyout firm general partners, much like the coveted breezes on Wall Street, have returned to the scene and begun, after a prolonged hiatus, to once again aggressively shop the public market for acquisitions.
It has been a long time coming, investment bankers and general partners agree, and while most are hesitant to predict a return to the 1980s where buyout firms were able to rear their heads as contenders in auctions for multi-billion dollar companies, few are willing to ignore the recent activity as merely a coincidence.
“The trend is definitely related to depressed valuations of small-cap stocks,” says Kevin Callahan, a managing director at Boston-based Berkshire Partners. “The last 12 months have been the first time in many years where the public market pricing is on a par with the private market.”
Sources agree that the last eight months have seen more than a moderate return to the traditional public-to-private leveraged buyout, with several deals that have closed and several more that recently have been inked.
Most notably Lehman Brothers through its Lehman Brothers Merchant Banking Partners II fund this month closed its $1.35 billion buyout of Blount International Inc.-paying $30 per share for a 90% stake in the sporting goods and industrial equipment manufacturer that formerly traded on the New York Stock Exchange.
In addition, 1999 has seen buyout firms such as Berkshire, GTCR Golder Rauner LLC, TA Associates, Vestar Capital Partners, Littlejohn & Co. LLC, Bruckmann, Rosser, Sherrill & Co., Trivest, Kirtland Capital Partners, American Securities Capital Partners and The Dyson-Kissner-Moran Corp. close acquisitions of publicly traded companies with purchase prices that ranged from a little more than $150 million to more than $500 million. All told, 1999 to date has seen more than $3.69 billion in public market activity by buyout firms, according to BUYOUTS and affiliate Thomson Financial Securities Data. This compares with a total of a little less than $3.13 billion in public market buyouts by G.P.s for all of 1998-nearly $2 billion of which was comprised of just one deal, Hicks, Muse, Tate & Furst Inc.’s acquisition of LIN Television Corp.
In fact, Bill Morrissett, a managing director at investment bank Bowles, Hollowell, Conner, a division of First Union Capital Markets, notes that fully half of the public companies that his bank has sold in 1999 have gone to financial buyers, whereas none of the public companies Bowles Hollowell represented in 1998 were snagged by buyout firms. “It is a combination of the tremendous inflow of capital to private equity funds, allowing for some capital to burn, and the public markets that have been tremendously pushed,” Morrissett says, referring to the more than $55 billion that was raised by buyout funds in 1998 and a wave of investor interest in large-cap and Internet stocks that has consistently pushed market indexes into record territory.
Meanwhile, a slew of public market deals has been inked by buyout firms in the last several months, a sign sources say is proof that the public-to-private trend shown earlier this year is primed to continue, if not escalate, in the coming year.
This month saw an agreement by Willis Stein & Partners to acquire Nasdaq-traded Aavid Thermal Technologies, a producer of heat management products, for $260 million, or $25.50 per share, as well as a deal inked by VS&A Communications Partners to acquire HCIA Inc., a health-care information company, for $135 million, or $11 per share.
In addition, Boston-based Thomas H. Lee Co. earlier this year signed an agreement to acquire New York-based Big Flower Holdings, a marketing services provider that trades on NYSE, for approximately $890 million.
One investment banker sums up the situation simply. “The interest in this segment definitely has increased, and you have a lot more dollars out there now,” says Steve Cesinger, a managing director at Los Angeles-based investment bank Greif & Co., referring to the record sums raised by buyout firms last year. “Private equity groups have a lot more capital, and they are willing to take a little less return than a few years ago.”
According to Cesinger, Greif & Co. currently is representing two publicly traded companies that have been approached by several potential suitors from the ranks of buyout firms. Although Cesinger declined to name the companies, he did say the clients are service companies with more than $250 million in annual revenue and strong cash flow.
However, as great as the temptation is to say that general partners have allowed well-stocked war chests to fuel an overly aggressive-and expensive-acquisition spree, several sources note that the public market in the last year also has undergone a sea-change. “The values two years ago were about 20% higher, multiple wise, for these companies,” says Avy Stein, a managing partner at Chicago-based Willis Stein, referring to public companies with market capitalizations of less than $1 billion.
To be sure, most industry observers agree that public market activity by financial buyers proved relatively slow in 1998-hampered in the earlier months by a high-flying stock market that gave hungry strategic buyers a taste for making the most of their bulked up stock prices and later by the late summer stock market blip that scuttled some potential buyouts and sent G.P.s working on others reeling for quick solutions.
Dry Spell Sows a Bumper Crop
Ironically, sources now partially attribute the spate of activity in the public market this year to the very same blip that limited the number of public companies that were taken private last year. When the market tightened, many small-cap public companies, defined as companies with annual revenue of less than $1 billion, found themselves in a precarious situation, still recording stable cash flow but watching their share prices drop with most of the rest of the market.
“Last September, with the market debacle, and during the last quarter of last year the Russell 2000 Index and many micro-cap stocks got crushed and just did not come back until this spring,” says Warren Smith, a managing director at Thomas H. Lee Co. “You had all these small-cap companies that just got slaughtered and were trading at a fraction of their costs. We looked at a lot of companies that fit that description.”
In addition, sources also offer several other reasons for the rush of recent deals, including a market that until recently had demonstrated an almost insatiable appetite for Internet-related companies. “In the public markets for middle-market companies you have seen pricing come way down. It is almost schizophrenic,” says Willis Stein’s Stein. “You have meteoric valuations for Internet companies, and for most everything else pricing is down.”
“Private equity groups have a lot more capital, and they are willing to take a little less return than a few years ago.”
Thomas H. Lee Co.’s Smith points to this year’s IPO market as a barometer for overall investor interest, noting that traditional manufacturing and service companies have had a difficult time attracting public capital. “For the whole year, the new issue market has been focused on the Internet, and if you are just a land-based traditional business, you just could not get investor interest,” he says. “That being said, the value players and small-cap companies have had a very good year.” Smith offers his firm’s pending acquisition of Big Flower as just such an example of a small-cap company that had seen its stock price buffeted but still posted strong earnings this year.
The Internet craze notwithstanding, some sources point more to overall investor interest in the public market, which has bulked up the market value of many blue-chip companies. “There is probably a trend for analyst coverage toward the Internet, but the bigger trend is probably that market capitalizations have increased, and [small-cap] companies that used to get decent coverage are now getting less,” says Jeffrey Stevenson, managing general partner of VS&A Communications Partners.
The increased number and prominence of mutual funds as public investors also has fostered an increase in the amount of money going into large-cap companies, sources say, because mutual funds have a need for liquidity that more easily can be granted by buying stock in large companies rather than micro-cap businesses. And following this trend, sources note that analyst coverage increasingly is focused on large-cap stocks because the brokerage houses and investment banks that employ these analysts can make more money moving more shares of large companies than shares of companies that occupy the small-cap market.
The lack of analyst coverage for this niche has been further exacerbated by recent investment banking mergers, most notably the merging of NationsBanc Montgomery Securities and Bank of America and the agreed merger of BankBoston and Fleet Bank. Sources note that the analysts at NationsBanc and BankBoston traditionally had focused more on small-cap public companies, but now are stepping in line with their acquirers in dedicating the majority of their resources to following large-cap companies.
Debt Markets Return
Of course, all of the opportunities and lower pricing in the world would not aid G.P.s in acquiring public companies if the lending market-especially for high-yield bonds-which largely had shut down in the second half of last year, had not rebounded this year. “With respect to last year, many public companies are of a size that, if an LBO firm is going to take them private, that would require a high-yield offering,” Bowles Hollowell’s Merritt says. “Now, although it is still spotty, you can get [high-yield deals] done.”
While sources agree that public market activity by buyout firms has increased this year and may likely increase even more in 2000 and beyond, most say they do not envision a return to the 1980s when LBO shops were competing against strategic buyers and corporate raiders for control of multi-billion dollar companies.
Still, if far from comparable with the public market activity in the last decade, today’s interest does at least show that buyout firms can return to their roots in what has become a radically different deal-making environment. “We looked at a number of these deals in the 1980s, and then it sort of went by the wayside,” says Berkshire’s Callahan. “Now, we have come full circle to looking at these deals again.”