In December 2006, THL Capital co-president Scott Schoen gave a keynote speech at the Yale SOM Private Equity Conference. In it, he laid out what I began to refer to as the LBO Win-Win Model. If debt continued to be cheap and readily available, buyout shops won because they were able to buy outsized targets with someone else’s money. If debt became more expensive and scarce – a situation Schoen acknowledged was forthcoming – then LBO firms could benefit because acquisition target valuations would drop (particularly given that most firms would have lots of dry fund powder).
In other words, it would be a return to the days of buying low and selling high, as opposed to the 2006 strategy of buying high and selling higher.
Schoen’s model sounded reasonable at the time, but he clearly did not anticipate the credit markets seizing up to the magnitude which they have (not blaming him, very few saw this coming). So I’ve spent the past few days talking with buyout pros not only about the Win-Win Model, but also about the more fundamental question of LBO market viability. After all, don’t LBO firms argue that it is the very use of leverage that enables them to outperform public market indices? If they become glorified PIPE shops or focus on all-equity transactions (like Neuberger Berman), how do they still justify 2 and 20? In short, are we only left with BO once the L is removed?
The answer, I’m told, is that you’ve gotta have faith. Not faith in individual investors or firms, mind you, but faith in the economy at large.
“Our bet is that the markets and economy will grow over the next five years, despite the troubles we’re having today,” one senior private equity investor told me. “It usually does, and our fund structures give us the flexibility to wait it out.”
It’s true that the private equity industry has a special ability to handle economic downturns, because of its long-term nature. An investment can be written down 80% today and ultimately produce a positive return without much intervening pressure to liquidate. There are obviously exceptions – namely portfolio companies that can’t service their debt – but playing macro market cycles is a big part of PE investing.
Such an argument is mostly about monetizing past deals, but I also hear faith when it comes to the credit markets reopening.
“The verdict is in, and we now know that the deals done over the past few years rested on debt that was titanically mispriced,” says another senior LBO investor. “So the credit markets won’t look like that again in our working lifetimes, but buyouts were a very good business for a long time before the excesses of 2006 and 2007, so I’d guess that the credit markets will come back to a baseline level.”
That’s not quite predicting future nirvana, but still has the effect of discounting the impact of current market conditions. As such, it largely makes Schoen’s Win-Win Model irrelevant (even though the end result of “win” remains intact).
Unfortunately, I can’t accept either verdict. First, faith is just not an acceptable strategy for folks managing billions of someone else’s dollars. History is not always a good indicator of future performance, as shown by the Dow closing lower on Monday than it did on the day of President Bush’s inauguration eight years ago. Second, the Win-Win Model simply does not account for our current credit crisis. Schoen works for a firm that often does deals in excess of $1 billion, and today’s banks will simply not write commitment letters for such things.
So let me propose something new: The Win-Win-Win Model. This accepts Schoen’s initial theory, but adds a third leg for when the credit markets are tight-to-absent. In those times, LBO firms can become one of the only providers of capital to companies who have traditionally accessed the credit markets for expansion purposes. Many of the actual transactions would be equity-heavy or equity-only, but would involve strong companies that normally would steer well clear of private equity in more lenient markets (motivated sellers forced to undervalue themselves).
In other words, LBO firms get to become the capital source of first and last resort. It may sound parasitic, but it’s really more mutualistic (particularly if it doesn’t involve much new leverage).
Win-Win-Win is admittedly a shaky theory, requiring a whole stack of matchbooks to keep the stool steady. It also puts an even greater emphasis on PE firm ability to pick growing companies in growing markets (here and abroad), as opposed to picking ones whose balance sheets can be easily rearranged. Indeed, many LPs I spoke with were unconvinced, with one foundation manager blurting out that “the leveraged buyout model is dead.”
So perhaps I’m being overly optimistic in saying that the LBO market will not collapse from its excesses, at least on a grand scale (certain firms will indeed go under). To me, Schoen had it right, even though he missed a piece. And those who have faith will be rewarded, even if they don’t deserve to be.
*** Some very quick data from Thomson Reuters:
Q3 U.S. PE fundraising (excluding VC): $56.8 billion, 50 funds
Q2 U.S. PE fundraising (excluding VC): $59.4 billion, 85 funds
Q3 global PE fundraising (excluding VC) $64.2 billion, 69 funds
Q2 global PE fundraising (excluding VC): $84.8 billion, 117 funds
Q3 PE deal volume (U.S.): $19.2 billion, 251 deals
Q2 PE deal volume (U.S.): $25.0 billion, 267 deals
Q3 PE deal volume (global): $63.7 billion, 624 deals
Q2 PE deal volume (global): $67.3 billion, 768 deals
I’ll also be posting a bunch more data to peHUB later this morning, including some VC stuff…
The City of Chicago has agreed to lease its Midway Airport to a group led by Citi Infrastructure Investors. The $2.52 billion deal would be the first privatization of a major U.S. airport. Participating alongside Citi is YVR Airport Services Ltd. and John Hancock Life Insurance Co. Five other groups had submitted bids.
Accellos Inc., a Colorado Springs, Colo.-based provider of supply-chain execution solutions, has raised $28.5 million in Series B funding. Monitor Clipper Partners was joined by return backers like Centennial Ventures. Part of the proceeds will be used to acquire Prophesy Transportation Software, a provider of solutions to the trucking industry. Accellos had previously raised around $22 million.
Ciena Capital, a provider of commercial real estate loans of up to $10 million, has filed for bankruptcy protection. It is a portfolio company of Allied Capital, whose shares fell 49% yesterday on the news, to an all-time low. Allied said it would pay around $320 million to lenders related to Ciena’s credit facility, using both cash-on-hand and perhaps borrowing up to $170 million.
Zvents, a San Mateo, Calif.-based local search engine and advertising network, has raised $24 million in fourth-round funding. Nokia Venture Capital, AT&T and Navteq were joined by return backers VantagePoint Venture Partners and Red Rock Ventures.
Metaforic, a Glasgow, Scotland-based provider of anti-tamper solutions for software, has raised $2 million in VC funding from Pentech Ventures and the Scottish Co-Investment Fund.
ZocDoc, a New York-based provider of physician finder and appointment booking services, has expanded its Series A round to include investments from SalesForce.com founder/CEO Marc Benioff and Amazon.com founder/CEO Jeff Bezos. No financial terms were disclosed. ZocDoc had previously raised $3.3 million led by Khosla Ventures.
Alpine Investors has made an undisclosed investment in high-end lighting products seller YLighting, according to peHUB.
Crédit Agricole Private Equity and CIC Finance have sold their stake in Ital Express, a French distributor of spare parts for HGVs and tractors, to La Financière Patrimoniale d’Investissement (LFPI). No financial terms were disclosed. LFPI was already a shareholder in Ital Express, having participated in the 2005 buyout of the company alongside Crédit Agricole and CIC.
CVC Capital Partners has agreed to acquire a 47.5% stake in Pilot Travel Centers, which would form an equal governance partnership with Pilot Corp. The CVC stake is being purchased from Marathon Oil Corp. for an undisclosed amount. PTC operates the largest travel center network in the United States with 305 locations in 40 states.
Gores Group has completed its acquisition of a 51% stake in Siemens Enterprise Communications from Siemens AG, which will retain the other 49 percent. The deal is structured as a joint venture, with the companies committing to invest at least €350 million into SEC, which provides unified communications, contact centers and secure networks.
Hudson Clean Energy Partners has acquired Helium Energy, a Madrid-based renewable energy development company. No financial terms were disclosed. Helium will be integrated into Hudson’s Element Power platform, which will focus on utility-scale wind and solar development throughout the globe.
The Riverside Company has acquired DuBois Chemicals Inc., a Racine, Wis.–based maker of specialty chemicals and solutions for manufacturing problems and lean initiatives, from JohnsonDiversey Inc. No pricing terms were disclosed. Key Bank and US Bank provided senior debt, while New Canaan provided mezzanine debt.
The Riverside Company has acquired Eemax Inc., an Oxford, Conn.–based maker of tankless electric water heaters. No financial terms were disclosed.
Water Street Healthcare Partners has acquired HealthPlan Holdings Inc., a Tampa, Fla.-based provider of outsourcing services to insurers in the individual, small business, union trust and voluntary benefits markets. No financial terms were disclosed.
The Blackstone Group and JPMorgan Chase & Co. reportedly are arranging a $1 billion financing package that would be used to convert 20,000 U.S. cinema screens to digital technology.
L Capital, the private equity investment arm of luxury group LVMH, has agreed to sell French video game retailer Micromania to GameStop (NYSE: GME). The deal is valued at approximately $700 million, and is expected to close later this quarter, pending European regulatory approval. GameStop will fund the acquisition through existing cash and a $150 million term loan from Bank of America.
Intersil Corp. (Nasdaq: ISIL) has agreed to acquire Kenet Inc., a Woburn , Mass.-based fabless maker of ultra-low power analog-to-digital converters. No financial terms were disclosed. Kenet has raised around $25 million in VC funding since 2002, from firms like Venrock, Oak Investment Partners, MIT and Kopin Corporation.
Nokia has agreed to acquire OZ Communications, a Montreal , Canada-based provider of consumer mobile messaging solutions. No financial terms were disclosed for the deal, which is expected to close later this year. OZ Communications has raised around US$61 million in VC funding from firms like Caisse de dépôt et placement du Québec, Fonds de Solidarite and VantagePoint Venture Partners.
Olympus Partners is whittling down the list of potential buyers for insurance brokerage Tanenbaum-Harber Holdings, according to LBO Wire. The firm is hoping to get bids of between $200 million and $300 million, with Banc of America Securities running the process. http://www.tanhar.com/
Riverside Partners has completed its sale of MicroCal to GE Healthcare for an undisclosed amount. MicroCal is a Northampton, Mass.-based maker of microcalorimeters that provide detailed information on the structure, function and binding properties of a wide range of biomolecules such as proteins, lipids, nucleic acids and antibodies.
SRA International Inc. (NYSE: SRX) has acquired Era Corp., a Reston, Va.-based provider of surveillance technologies for the air traffic management, airport operations, military and security markets. No financial terms were disclosed. Era had raised over $10 million in VC funding from Boulder Ventures, plus some acquisition financing from Mezzanine Management.
Accel-KKR has sponsored a merger between portfolio company iTradeNetwork Inc. and Amphire Solutions, in order to create a single provider of software applications to the food, hospitality and healthcare industries. No financial terms were disclosed. Accel-KKR had acquired a majority stake in iTradeNetwork last December.
Emdeon, a provider of revenue and payment cycle management solutions for the healthcare industry, has acquired GE Healthcare IT’s patient statement business. No financial terms were disclosed. Emdeon is in registration for a $460 million IPO, and is backed by General Atlantic and Hellman & Friedman.
H.I.G. Capital has helped form Epic Production Technologies, by sponsoring the merger of Q1 Production Technologies (Canada) and Ed & Ted’s Excellent Lighting (Los Angeles). No financial terms were disclosed for the deal, which creates a single provider of lighting systems for concert tours, theatrical productions and corporate and special events.
Ray Newton IIIhas joined Evercore Capital Partners, the private equity group of Evercore Partners, as a senior managing director. He previously was a senior managing director of Perseus LLC, and was with J.H. Whitney & Co. before that.
New Enterprise Associates has made several promotions: Harry Weller to general partner, Rohini Chakravarthy and Jon Sakoda to partner and Ali Behbahani to principal.
Storm Ventures has promoted Ben Choi to principal, and hired Bill Shetti as a senior associate. Choi joined the firm in 2006 as a senior associate, while Shetti most recently worked in business development and product management at Cisco Systems. http://www.stormventures.com/
The Blackstone Group has hired 12 corporate advisory pros to form a team in Asia. It includes partners Anthony Steains (formerly with Lehman Brothers) and Jianping Zheng (HSBC), plus managing directors Johan van Jaarsveld (Lehman), Dong Hyun Lee (Lehman) and Jing Xiaowen (HSBC).