It’s become almost reflexive in the last two months for mid-market players to declare that deal flow hasn’t halted as a result of the credit freeze that’s brought the mega-deal market to a virtual standstill.
But is the mid-market indeed chugging along? The number of deals last month with disclosed values of less than $1 billion backed by U.S.-based buyout firms fell by about 16 percent year-over-year between August 2006 and August 2007, according to Thomson Financial, publisher of Buyouts. The number of mid-market deals with disclosed valuations in July fell by about the same amount year-over-year, according to Thomson Financial. The dollar volume of deals valued at less than $1 billion fell, too, year-over-year between July and August 2007 and the same period a year before. The two-month total fell $10.5 billion, down from $11.8 billion, according to Thomson Financial.
That sample, however, doesn’t include middle-market deals that don’t carry disclosed values. Overall mid-market M&A activity, measured year-over-year, remained relatively flat in July and August compared with a year before, according to mid-market investment bank Robert W. Baird, which crunched numbers from Thomson Financial. “The pace has slowed in the middle market, but not as quickly as in the large market,” said Steven Bernard, Baird’s director of M&A Market Analysis.
Whether deal activity is off significantly—or not all—seems to depend on the eye of the beholder. “I have not seen a slowdown at all,” said Walter Holzer, a partner with law firm Jones Day in Chicago, who closed three deals in the last month. “As long as they don’t have to syndicate a loan, the tenured buyout shops will get deals done.”
On the other hand: “I just don’t know what deals … people are working on,” said A.J. Weidhaas, a partner in the New York office of Boston law firm Goodwin Procter. “I think the impact is becoming more apparent.”
Whether deal pace is slowing or holding steady, it’s clear the deal-making environment is far different than it was three months ago, even in the middle-market. If a deal is valued at more than $100 million, lenders start getting a lot more demanding, said Chrisanne Corbett, head of the financial sponsors coverage team for KPMG Corporate Finance. It’s not uncommon these days for buyout firms to agree to re-price debt at 150 basis points or 200 basis points higher than what was initially agreed to in order to get a deal done. At the very least, lenders are now asking buyout firms to accept 150 basis points in flexibility—meaning the loan terms could change post-close—as a condition of granting a loan, Corbett said.
In a recently closed deal, Weidhaas said his client was asked by the lender to agree verbally to come back at some point during the first quarter post-close to renegotiate the terms of the debt agreement. “Mid-market private equity shops have a lot of deep relationships with lenders,” Weidhaas said. “There’s a fair amount of goodwill.”
These concessions and negotiations are vastly different from the easy credit days of earlier this year, when buyout firms held more sway over financing terms. “There’s still financing out there,” said Corbett, adding that she’s seen little slowdown in activity. “And if we can’t get all the financing, [LBO firms] will put in more equity.”
Indeed, if deals are getting done, it’s not on the same terms as before, said Michael F. Turner, partner in mid-market investment bank Farlie Turner & Co. in Ft. Lauderdale, Fla. “There’s a new reality in the marketplace, and firms need to operate in the new reality,” he said. “In some cases, that means revisiting the capital structure or taking a second look at price.”
The lingering question for the middle market is whether recent changes in deal structures are temporary or whether they signal a permanent, multi-year change in landscape, Weidhaas said. “Is this a momentary step back until the large market straightens out?” he asked.