Buyout industry professionals are expressing surprise at a drop in mid-market deal volume following what looked like a healthy rebound in the fourth quarter of 2010.
Most pin the rise in deal activity late last year to expectations that taxes would increase in 2011. By the time Republicans won control of the House of Representatives and it became clear that that wouldn’t happen, many deals were already near closing.
“There was a pig going through the snake in the last half of last year because of anticipated tax changes,” Watts Hamrick, managing partner of the Charlotte, N.C.-based mid-market firm
Take as a case in point the New York-based firm
Since then, though, Welsh Carson Anderson & Stowe has been quiet on the deal front. But co-founder Russell Carson expects deal volume to pick back up in the coming months.
“A lot of people tried to get things done by the end of the year and are now working on other projects that will probably come to fruition in March,” he said at a conference late last month.
There was $1.6 billion of loan volume slated to finance mid-market leveraged buyouts, with another $1.2 billion in the pipeline as of Feb. 24, according to Thomson Reuters LPC, which characterizes the mid-market as sponsor-backed deals for issuers with sales of up to $500 million.
That’s an improvement over the first quarter of last year, which saw $1.58 billion of loan volume. But it’s paltry when compared with the fourth quarter of 2010, when there was $6.5 billion of loan volume for mid-market LBO deals.
Randy Schwimmer, a senior managing director and head of capital markets at mid-market lender Churchill Financial LLC, agreed that expected tax changes played a role in the lull.
But he had expected that the combination of robust capital markets and the amount of capital private equity firms raised in recent years but have yet to spend would keep momentum behind new LBO activity, two factors he still believes will drive a fresh spike in deals. The number of dividend recapitalizations has surged, and by various estimates the overhang of un-deployed capital is between $400 billion and $500 billion.
Schwimmer said he believes two other factors, besides anticipated tax changes, are also responsible for the slowdown. For one, he said a disconnect exists between sellers anticipating better performance from their companies this year as the economy improves and buyers who remain skeptical given how fragile the recovery is.
Second, market participants still rattled by the debt crises in Europe last year are concerned about unrest in the Middle East. This could lead to rising oil prices that could stifle the economic recovery in the United States and elsewhere, Schwimmer said. That could spook would-be buyers, who may be unsure of how a company might perform if the nascent recovery stumbles.
“People are nervous about another shoe dropping,” Schwimmer said. “I think there’s more than a residue of caution about possible galactic events.”
Some bankers insist deal activity will return with fervor in the coming months.
“Possible tax changes may have contributed to the rush of deals last year and exacerbated seasonality by pushing some transactions forward into 2010 that might otherwise have been timed for 2011, but our pitch and retention activity feels absolutely frenzied,” Justin Abelow, a managing director at the investment bank Houlihan Lokey Howard & Zukin, told Buyouts. “Our teams have, with some exceptions, not been too busy bringing companies to market over the past two months, but they are working around the clock to ready companies to enter the market soon.”