Mid-Market Off To Slow Start In 2011

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.

Through Feb. 24, $1.6 billion of loan volume had been issued to finance U.S. mid-market leveraged buyouts, with another $1.2 billion in the pipeline, 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.

The year-end and year-start activities of New York-based firm Welsh Carson Anderson & Stowe help illustrate the trend. In the fourth quarter of 2010, the firm sold no fewer than five companies, bringing its 2010 distributions to investors to $2.2 billion. The firm also bought two companies in that time. Since then, though, Welsh Carson has been quiet on the deal front. 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.

Most pin the rise in deal activity late last year to expectations that taxes on capital gains would increase in 2011. By the time Republicans won control of the House of Representatives in the November elections 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 Pamlico Capital, told Buyouts. “If you assume a lot of those deals would’ve gotten done this year, the activity level is down but it’s down from an artificial peak.”

Randy Schwimmer, a senior managing director and head of capital markets at mid-market lender Churchill Financial LLC, 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.”

Meantime, some bankers say 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.”