Private Equity M&A Influence Ebbing With Traditional Acquirers On The Mend, Private Equity Has To Share The Spoils –

Private equity players, which were critical to the hobbled merger-and-acquisition market over the past three years, could at last be eclipsed this year by the return of more traditional strategic buyers, market sources said.

As the economy improves this year, dealmakers expect strategic buyers to displace financial buyers, such as private equity players. Since 2001, most strategic buyers have struggled just to stay in the black and so have kept out of M&A, leaving the field open to private equity players. That trend, however, appears to have ended.

In the first quarter, U.S.-based private equity acquirers made up only 11.5%, or $34.9 billion, of total U.S. acquisition volume of $304 billion, according to Thomson and researcher R.W. Baird. That is lower than in the first quarter of 2003, when U.S. private equity acquirers spent less-$14 billion-but because deal volumes were so low, they accounted for 16% of the total. For all of 2003, private equity buyers contributed 15% of the total U.S. volume, according to Thomson and R.W. Baird.

It’s not that private equity firms are reducing M&A activity. On the contrary, analysts expect private equity players to be just as active, if not more so, in M&A this year. It’s just that private equity will have much more competition. “The dollar value of transactions by strategic and financial buyers will grow year to year, but the percentage of strategic buyers will be higher,” says Kevin Callaghan, managing director with Boston-based Berkshire Partners.

The difference is that strategic buyers are recovering and have to seriously consider acquisitions in order to grow, says Ken Csaplar, managing director with Trenwith Securities LLC in Boston. “Strategic buyers have to show positive growth,” he said, adding that now that many strategic buyers have their houses in order and their stock value has increased, these buyers can use their shares as acquisition currency more readily.

The decrease in the relative contribution of private equity buyers to the M&A picture comes even as the overall announced U.S. deal volume has improved. In the first quarter, U.S. M&A deal volume jumped a whopping 270%, to $304 billion, compared with $82 billion in the first quarter of 2003. The first-quarter total represented more than half of 2003’s entire volume, according to R.W. Baird.

At the same time, private equity firms are busy trying to invest the funds they have raised and typically must invest within five to seven years, said Csaplar, who says his phone is ringing constantly with funds looking for investments. Some have a very short window in which to invest, turn a profit and provide a return to their investors.

Adding to the pressure, interest rates are expected to rise in coming months, making financing more difficult. M&A sources say that a 1% to 2% hike will have little effect, but if rates rise beyond that, private equity investors don’t rule out a decline in exit multiples.

Ross Jones, managing director at Berkshire Partners, which recently found a promising investment in the fast-growing MD Beauty Inc. line of cosmetics, says that private equity investors have already taken rising rates into account. “The industry will have that challenge going forward,” he said.

-This originally ran in Investment Dealers Digest, a sister publication