For the first time in a long while, players in the buyout market are enjoying relative stability. With the financing market easing a bit, the economy on the mend and valuations steadying, deal flow has continued at a healthy pace. Third quarter numbers confirm that the $33 billion first half of the year was no anomaly.
Last quarter saw 136 deals completed with disclosed values totaling $21.45 billion, bringing deal volume to an eye-popping $55.3 billion-quickly approaching 1999’s full year total of $63 billion.
“I think this has been a pretty good year in the buyout world, and there’s a much greater sense of equilibrium,” says Jamie Singleton, vice chairman of The Cypress Group. “There’s a strong divestiture market in place and when you combine that with a good interest rate environment and strong capital markets, you’ll have a good environment for private equity, especially since the general market tone hasn’t yet created a big competitor [in the form of corporate buyers].”
Nearly one-third of the third quarter volume came from four mega deals, the largest one being The Carlyle Group and Welsh, Carson, Anderson & Stowe’s $4.3 billion deal for the second half of Qwest Communications’ QwestDex. Other mega deals that closed in Q3 include One Equity Partners’ $1.8 billion acquisition of Quintiles Transnational, DLJ Merchant Banking Partners’ $1.2 billion LBO of Jostens Inc. and Warburg Pincus’s purchase of TransDigm, also valued at $1.2 billion.
What’s perhaps most significant about these mammoth transactions is what they say about the debt markets. “I think it’s a function of the finance markets coming back. We’re seeing debt multiples creep back up-in certain cases reaching the four-to-five times range-and there is definitely more competition in the mezzanine market,” says David Moross, founder and managing director of Falconhead Capital.
Cypress Group’s Singleton adds: “The high-yield market has been busy in the last 18 months. Since March of this year it has been particularly healthy, and we don’t see anything on the horizon that will change its tone anytime soon.”
Still, even as financing has slowly made its way back into the market, most pros complain that the debt-to-equity ratios in their transactions haven’t changed much. Today most deals are still using a roughly 40% equity contribution despite the rejuvenated capital markets.
“We don’t see [equity contributions] falling. We see a pretty wide variation, but on balance it’s staying around 40%, and nobody is predicting a return to the 5% to 10% days. It could stick at the mid-to-high thirties,” says Mark Opel, a principal in American Capital Strategies’ New York office.
Middle Market Making Noise
While the larger market deals generate the most press, it’s the middle market is where most private equity firms are focusing their attention. “The middle-market is the hot market right now,” Moross says. “There are a lot of opportunities and values to be found, and at the end of the day, it’s a very efficient market.”
Of the 87 deals that disclosed an enterprise value in the third quarter, 39 had a purchase price of between $100 million and $500 million. Among the more notable middle-market transactions, a team of Trimaran Capital Partners and Bear Stearns Merchant Banking acquired Packaged Ice in a $450 million public-to-private deal, while a Wand Partners-led investment group acquired Winterthur’s Republic insurance unit in a $127 million deal.
Most middle market buyout pros will also tell you that the returns generated from the smaller end of the deal spectrum have more upside than the larger market because they have more room to grow. Further, the chance to bypass an auction in the middle market, while not always an option, is another draw for buyers.
Meanwhile, sellers in the middle market, most of whom refrained from cashing out during the economic downturn, have slowly started to return to the fray. Nicholas Somers, a partner with Schroder Ventures, says: “Entrepreneurs and family businesses are not holding out for double-digit multiples anymore and companies that survived the recession are now looking for capital for future growth.”
Glenn Gurtcheff, director and co-head of US Bancorp Piper Jaffray’s middle-market M&A group, agrees: “More private companies are starting to re-enter the marketplace. To a very large extent they went away [the past couple years]. Their businesses were not performing and there was nothing to do with the money [from a potential buyout]. There needs to be a stimulus before the sellers will return.”
Helping keep the deal volume high, buyout firms continue to shop across the pond, looking to capitalize on the less crowded European and Asian markets. It’s not uncommon to hear of firms like KKR, Carlyle, Ripplewood or TPG participating in the pricey auctions that have been sprouting up on these continents, while firms like Advent International remain active in the global middle market.
“Around the world it’s shaping up to be a pretty solid year,” says Advent Managing Director Doug Kinglsey. “We’re seeing a lot of U.S. money coming over to Europe. Part of it is that the U.S. is a very mature market and is very competitive.”
The Fiat Avio deal was one of the more notable international acquisitions completed by a U.S. buyout shop last quarter. Other deals included Cerberus Capital Management and General Atlantic Partners’ $135 million acquisition of Baan, and JPMorgan Partners and CVC Asia Pacific’s buyout of Singapore Telecommunications’ yellow pages unit.
Among the high-profile transactions that have yet to close, Ripplewood made headlines with its acquisition of Vodafone’s Japan Telecom fixed-line operations for $2.22 billion. Also, CVC and TPG are near the end of their bid for Debenhams, a U.K. retailer.
Most GPs who enter the European space say that the banking environment on the senior-debt side is better suited for buyouts than in the U.S. because of the increased competition among the lenders. And while the maturity of the market is catching up, the cycles in the economies are producing the same rush of corporate divestitures that the U.S. market has seen for some time now.
For the near future LBO firms will continue to compete with each other in most transactions unimpeded by competition from corporate buyers. “As the strategic buyers have backed away, the private equity community has become very much a co-equal player. In years gone by, if strategic buyers were interested, a financial buyer couldn’t win, but in this environment there is a tremendous opportunity for the financial players to pursue and capture high quality assets,” says Singleton.
However, looking ahead to 2004, it’s expected that the corporates will come back. The public markets are improving, giving the large public players more cash at their disposal. Gurtcheff predicts it won’t be long until the strategics re-enter the picture. “Private equity groups will find it increasingly difficult to compete. They’ve largely had the field to themselves and the strategics are coming back into the picture,” he said. “It will come down to how low will they be willing to lower their returns if they really want to compete.”
The arrival of the corporate buyers isn’t all bad, though, as the buyout players who took part in the recent buying binge should have any easier time finding an exit, and most likely at a better multiple.
Recently, a Silver Lake Partners-led sale of Crystal Decisions to Business Objects for $820 million demonstrated a returning interest from the corporates to spend cash.
“There’s been a sustained upturn in the market and we’re finally starting to see some exits,” says Erik Hirsch, chief investment officer with Hamilton Lane. “There have been some strategic sales, some IPOs; it’s been getting better.”