Despite the tough economic times and grim outlook, the number of buyout deals completed in the third quarter might not be as scary or as shockingly low as one might expect. According to Buyouts data, firms completed 44 deals in the third quarter, totaling about $3.95 billion in disclosed values.
Compare that to the second quarter this year when GPs closed 32 deals – the lowest total deal volume for any quarter since 1996. Interestingly, that quarter they actually invested $57.5% more than in the third quarter, putting out $9.3 billion, versus Q3’s almost $4 billion. (Buyouts originally reported 30 closed deals equaling $6.95 billion for the second quarter (July 2, p. 1), but adjusted its numbers to last-minute deals such as Forstmann Little & Co. affiliate FLCC Holdings Inc.‘s acquisition of Citadel Communications Corp. for approximately $2 billion, and New York-based Veritas Capital $270 million purchase of Raytheon Aerospace Co., a provider of aviation and aerospace technical services and subsidiary of Raytheon Aircraft Co.)
In the third quarter, the hit came to the larger deals. In fact, the average deal size for the third quarter was roughly $87 million. With the exception of Heartland Industrial Partners‘ acquisition of Springs Industries for just under $1 billion and Kelso‘s deal with Armkel for under $800 million, the three next largest deals announced in the third quarter are still pending. These are Berkshire Partners‘ announced acquisition of apparel retailer The William Carter Co. for $450 million; J.W. Childs and Halifax‘s combined pending acquisition of InSight Health Services Corp. for $255.7 million; and Texas Pacific Group‘s agreement to acquire Norway’s Telenor Media for $666 million.
Terror in Q3
Some were surprised that TPG and Telenor signed their deal just days after the Sept. 11 terrorist attacks in New York and Washington, D.C. Generally, there is disagreement among GPs about the effects of the attacks on the market and on the state of the buyout environment. Some say people were hungry to get more work done before Sept. 11, while others claim the attacks may force the business to get out of this year’s lull.
The attacks “ensure the economy goes into a recession,” says P. Andrews McLane, a senior managing director at TA Associates. “Everything is slowing way down.”
David Mayer, a partner at Thoma Cressey Equity Partners in Chicago says he believes the attacks have resulted in GPs rethinking their portfolios.
“People are saying, We thought we knew where we were.’ Now they’re asking, do we have any clients we need to question the merits of receivables? How is this going to affect us in six months?’ People are revisiting the issues they’ve been [discussing] for the past nine months to make sure everything is covered,” Mayer says.
Still others say it was too soon to calculate the economic damage caused by the attacks.
“No one knows how to assess the impact of something like that,” says Mike Lyons of Lincolnshire Management Inc., which closed on a $61 million deal for sports brand Riddell in the third quarter.
GPs are predicting, though, and with few exceptions, that the attacks of Sept. 11 will affect how they do business. Writing in the The New Yorker last week, James Surowiecki said, “In the past couple of years, companies made tentative moves cutbacks in travel budgets, renegotiated corporate deals with airlines toward changing their approach [to air travel]. After Sept. 11, there was no longer anything tentative about it. Businesses started grounding their executives.”
Johnny Lopez, the executive vice president of mergers and acquisitions at Los Angeles-based Platinum Equity, called from JFK airport. “It’s evident to me people are not traveling for business,” he says.
As a result, some sources say they expect buyout firms to gravitate toward doing deals closer to home, or at least to find other ways of communicating, like tele- and video-conferencing.
On the other hand, McLane of TA Associates says doing deals closer to home would be very limiting. “I can’t imagine sophisticated players like KKR, for example, only doing deals in New York and Silicon Valley,” he says.
Both Platinum and TA Associates made investments in the third quarter, Platinum acquired Motorola’s Multiservice Networks Division (MND) and health-care company Amisys 3000; and TA Associates purchased semiconductor packaging manufacturer Ixion Technologies. At the time of the Platinum-Motorola deal, Lopez acknowledged the buy was part of a larger trend of companies selling their non-core divisions. This trend, he says, has continued to give LBO firms “significant opportunities,” no matter the state of the economy.
Back to Business
Where do buyers and sellers stand now? Many buyout firms are hopeful that the extra stimulus the Federal Reserve generated a week after the terrorist attacks will both help boost the economy, and make bank regulators soften their credit posture. Among GPs, the number one complaint all year has been the inability to get financing.
“The question is not whether there’s anything to buy, it’s that it’s difficult to get financed,” says Bill Barnum, a general partner at Brentwood Associates. “A lot of companies in consumer businesses are looking at Christmas sell-in. Other businesses haven’t figured out what’s happening yet. Everyone’s wondering if the consumer is going to show up. It’s hard to imagine it’s going to be [a] great [Christmas season].”
For most of Q3, the consumer was nowhere to be found. In fact, Brentwood’s portfolio company Oriental Trading Co., a mass market direct marketing catalog business, is 5% below where it was last year, Barnum says.
Letting one ray of hope filter in, Thoma Cressey’s Mayer says the Sept. 11 attacks may provide an ironic impetus to break the stalemate between buyers and sellers.
“In the second quarter, the feeling was there’s not a lot out there [to buy], and if it is, it’s out there for a reason,” Mayer says. “Most potential sellers were waiting for the ideal prices [that they’d seen before]. Now people are acknowledging prices were maybe not depressed, but were inflated. There’s the realization we may or may not ever see those prices again. Everyone has been waiting on the sidelines. It’s been a stalemate. Maybe it’s a defining moment – time again for buyers and sellers to meet, albeit at lower valuations.”
Ernest Jacquet, a managing partner with Parthenon Capital, agrees. “There’s a resurgence in interest on the part of owners. Owners are calling us now. There’s an acknowledgment it may be years before we get back to 1999 numbers,” Jacquet says.
This “new realism” among sellers, GPs say, may spur future growth in the buyout market as the sellers re-adjust their thinking about multiples and valuations come down. Thus, while overall the fundamental issues facing the buyout market remain the same, albeit with a finely tuned concern about where the economy is headed, some are optimistic about the first and second quarters of 2002.
“We may not see as many closings in the fourth quarter, but we will in the first and second [quarters], and deal activity will heat up,” Mayer says.
In the meantime, the industry sectors that GPs favored prior to the attack, such as health care, are the same sectors that are likely to remain in favor. Yet others say opportunities are inherent in a unique set of circumstances rather than industry-wide.
“The travel and hospitality industries are afraid they won’t see the bottom for a couple of years, [whereas] health care is relatively stable,” says Jacquet. “The attacks of Sept. 11 made [owners] realize the value of a strong financial partner, [and] preferably not a bank. Banks are notifying owners to bring down their debt.”
With all the money raised in 2000, buyout firms are looking for deals and have capital to spend. For example, Thomas H. Lee Partners, which made only one investment during the past 18 months, has more than $6 billion at its fingertips; KKR has raised a $4.5 billion fund, but established no new platforms in Q3; and Warburg Pincus has just under $3 billion of new money to spend.
Nevertheless, as the chairman and CEO of Allied Capital, Bill Walton, put it, “Most prudent people are interested in deploying their capital slowly.”
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