Talk about loosening the purse strings. Just two years ago, the buyout community closed a mere $23.1 billion worth of transactions, as a poor economy and slow M&A market kept sponsors on the sidelines. After having raised more than $60 billion of capital in 2000, the capital overhang in the LBO market quickly ballooned to more than $100 billion, and LPs were stuck paying management fees to GPs who weren’t producing returns or spending money.
Fast forward two years, and buyout firms have opened their wallets en masse. As Buyouts went to press, LBO sponsors had completed roughly $89 billion in disclosed transactions, a number that dwarfs any previous total from the past 15 years. While LP entreaties to invest were certainly heard, the main impetus for the spending spree was an alignment of the stars, so to speak, in which seller and buyer expectations finally moved closer together, while the economy improved and lenders started to ease their terms a bit.
“Most private equity sponsors finally have a good sense of where the economy is and where it’s going,” says Cypress Group President Jamie Singleton. “After two international conflicts and three years in a difficult economic environment, [buyout investors] can finally see the light at the end of the tunnel, and that has helped drive activity.”
To be sure, the staggering $89 billion figure was somewhat skewed by the storm of billion-dollar-plus mega deals, which came down on the market like softball-sized hail in 2003. In all, 24 billion-plus transactions represented more than 55% of the overall dollar volume for the year, while large market transactions-those over $700 million in value-represented more than 64% of the total volume.
“It has been robust on the large side. Throughout the whole 1990s there were maybe 10 or 11 control [buyout] deals with greater than $500 million of equity [contributed]. Since 2000, there have been more than forty,” says Jim Coulter, a co-founder of Texas Pacific Group.
The Blackstone Group was among the more munificent with its equity in 2003, taking part in the year’s two largest transactions: the $4.73 billion acquisition of the TRW Auto Division and the $4.35 billion purchase of Ondeo Nalco. Others active in the large market last year included blue-chip sponsors like TPG, Kohlberg Kravis Roberts & Co., Thomas H. Lee Partners, Apollo Management and GS Capital Partners, the latter two joining Blackstone in the Ondeo Nalco buy.
While the corporate carveout trend has created most of these large transactions, it’s the absence of strategic buyers that has allowed LBO firms to win the larger deals. “The key ingredient is that properties have to be made available. As the large public companies solve their problems and reorient themselves, they typically dispose of their largest assets first,” says Coulter. “In another era these businesses would have either been bought by strategics or taken public.”
Middle Market Activity
But it wasn’t just the big firms who were active last year. There were 476 deals with individual totals below $700 million, representing more than 94% of the number of transactions, which together had a combined monetary value of $31.61 billion, 35% of last year’s disclosed volume.
“When you compare the activity in the middle market to that of the large market, it has actually been more stable,” says Jeff Rosenkranz, a managing director and co-head of the middle-market M&A group with USBancorp Piper Jaffray. “The deal flow is generally more consistent and less cyclical than that of the large market.”
Glenn Gurtcheff, the other co-head and managing director at USB Piper Jaffray, adds, “There’s always an undercurrent of activity in the middle market because there are so many more opportunities out there, and it has always been a more fertile ground in which to play in.”
Riverside Co. and Sun Capital Partners remained among the most active acquirers in the middle and small markets, while Wind Point Partners and H.I.G. Capital Partners kept a healthy pace as well. Among the more notable middle-market deals were WL Ross & Co.’s acquisition of Burlington Industries and Carousel Capital’s purchase of Meineke Car Care.
While the surge in the middle market is largely due to the same economic factors influencing the entire private equity universe, there is some evidence that large market activity has trickled down to the middle market. “That the large market is starting to come back makes M&A activity more visible…Seeing deals on the front page of the newspaper helps to encourage potential sellers to come to market,” Rosenkranz says. Moreover, the fierce competition for some of the large deals has prompted some sponsors to move down market for smaller deals, where their fat wallets may have more influence.
Risk Taker, Heartbreaker?
Given the glut of deals in almost every industry, no one sector stood out in 2003. Technology and telecom deals together represented roughly 15% of all activity based on the total number of transactions. While it doesn’t quite induce a flashback to 1998, the move into those sectors signals that buyout investors may have reacquired their appetite for risk. Cerberus Capital Management’s and General Atlantic Partners’ purchase of Baan was one of the more talked about tech deals this year, while Pivotal Private Equity and Ripplewood Holdings each stepped back into the telecom sector-and not gingerly- with the purchases of Pacific Crossing and Japan Telecom, respectively.
“There was definitely more appetite for risk in 2003,” says Blackstone Vice Chairman Hamilton James. “This was driven primarily by the financing markets…firms could buy assets that couldn’t be financed a year ago.”
However, nobody expects sponsors to confuse their renewed thirst for risk as the “irrational exuberance” that was seen in the 1990s, as investors this time around seem to be sipping rather than quaffing down deals in the tech space.
On the other end of the spectrum, buyout shops also continued to be active in the “safer,” less cyclical sectors such as health care and food, which represented 9% and 7.5%, respectively, of the total number of transactions that occurred last year. One Equity’s acquisition of Quintiles Transnational Corp. and Welsh, Carson, Anderson & Stowe’s purchase of Ameripath each made headlines in 2003. And from the kitchen, Centre Partners’ purchase of Bumble Bee, The Shansby Group’s acquisition of Energy Brands and Cypress Group’s Meow Mix buy all stood out among the food deals that closed last year.
The larger buyout players continued to rack up their frequent flyer miles in 2003, showing a high level of activity overseas in both the European and Asian markets. Texas Pacific Group was among the most active U.S. buyers abroad, participating in a deal for U.K. retailer Debenhams and also acquiring Spirit Group, Scottish & Newcastle’s ex-managed pubs and restaurants division.
“Companies over there have been forced to sell assets-Vivendi is an example of that-and you’ve also got a generational change occurring over there,” Blackstone’s James says. He adds that the creation of the European Union and the transformation into one large market makes for a consolidation opportunity that is being pursued by the private equity shops.
Asia also charmed U.S. buyout firms. Ripplewood Holdings, now a regular in Japanese buyout circles, made the biggest splash there with its acquisition of Japan Telecom, a roughly $2.2 billion deal. The Carlyle Group was also active, buying crane manufacturer Kito Corp. in a public-to-private deal, while Newbridge Capital, an affiliate of TPG and another familiar face in the Far East, wrapped up deals for Hanaro Telecom and Asia Global Crossing.
Strategic Bumps in the Road Ahead
As buyout pros look into their crystal ball, most do not expect any significant drop-off in activity for 2004 (See story page 1). David Moross, the founder of Falconhead Capital, says, “This has not been a [temporary] blip at all. As the economy improves, I believe you’re going to see more and more deals coming into the market.” And as political issues start to settle, Moross believes that will also help encourage investment. “The economy is improving and there is more enthusiasm now. Geopolitically, I also think we’ve seen a settling this past year with the non-economic issues, which helps the psyche of the country and bodes well for more capital being invested.”
And as far as the limited partner community is concerned, the qualms have moved from whether firms will make investments, back to how well firms will make investments. Erik Hirsch, chief investment officer at Hamilton Lane, notes that for him, there was never a problem of sponsors not acting quickly or often enough on deals, although he admits many LPs would not hesitate to voice their concerns to the GPs. “The last thing we want to do is pressure firms to go out and do deals that are subpar,” he says. “Some GPs are lowering their return expectations in order to put money to work. The pressure to invest money has in some instances become the driving factor, rather than focusing on doing good deals and maximizing returns.”