Q1 Deals: Industrials Lead The Way

“The activity level in the second half of the quarter as far as new buyout opportunities is running at a much higher rate” than the first half, Bill Sanders, global co-head of sponsors group at Morgan Stanley, told Buyouts.

U.S.-based sponsors closed 222 deals globally as of March 21, with a disclosed deal value of $11.3 billion, according to data from Buyouts publisher Thomson Reuters. That’s a 26 percent drop from the 301 deals closed in the fourth quarter of 2011, and a 66.6 percent fall from the $33.3 billion in disclose deal value seen in the fourth quarter. With more than a week left in the quarter following our deadline for this article, those numbers will change, but it provides a snapshot of where the market was for much of the quarter.

Put in historical perspective, first quarter’s numbers marked a 43.5 percent decrease from the 393 deals closed in the first quarter of 2007, the start of the most active year for LBOs in recent memory, and a staggering 91 percent drop from the $124.4 billion of disclosed deal value in that quarter.“The uncertainty about the economy that was going on in the July-September timeframe created a gap in the pipeline,” said Lawrence Golub, founder of the mid-market lender Golub Capital.

Indeed, the first quarter is often the slowest for deal-making. But this year’s start was exceptionally slow given how many sources expect the year to turn out. Confidence is only starting to return following the volatility in global markets last summer caused by the European debt crisis and the political standoff in the United States over the debt ceiling.

“We noticed a good flow of opportunities, but it was not robust,” said Allan Holt, managing director and co-head of The Carlyle Group’s U.S. buyout group.

Momentum in the buyout market did pick up about midway through the quarter. As of March 21, there were 60 control-stake acquisitions that had been agreed to but not yet closed, compared to only 33 pending deals at the end of the fourth quarter of 2011. A number of those 60 pending deals will have closed by the end of the first quarter, but that number also far exceeds the 43 deals that were pending in the fourth quarter as of Dec. 15, 2011, the cut-off for Buyouts’s 2011 deal-making review.

Further, 39 of the 60 pending deals, or 65 percent, were struck on Feb. 13 or later, roughly midway through the quarter, a Buyouts analysis shows. The sheer size of the pending deals is also telling. While the largest deal closed in the first quarter was the $1.77 billion buyout of educational services provider SunGard Higher Education by Hellman & Friedman LLC-backed Datatel Inc., the largest pending deal is Apollo Global Management LLC and Riverstone Holdings LLC’s agreement to buy oil and gas exploration company EP Energy Corp. from El Paso Corp. for $7.15 billion; and the following two pending deals are valued at roughly $4.5 billion and $2 billion, respectively (see table for details). These three deals were struck on Feb. 17 or later.

Industrials Take Top Spot

For the first time since 2009, the industrials sector was the most popular place for private equity-backed acquisitions in the first quarter. That suggests sponsors are looking for more cyclical plays as the economy improves.

Sponsors completed 40 control-stake acquisitions in the industrials sector, accounting for 18 percent of the 222 deals closed in the quarter.“In terms of opportunities, the industrial sector in the U.S. is seeing a tremendous revival,” said Stephen Murray, CEO of CCMP Capital Advisors LLC.

Sources outlined several reasons why Industrials were most popular. For one, there’s a lot of pent-up inventory coming to market: Sellers, including large companies that have been wanting to divest non-core businesses, are only lately confident they can get acceptable bids for these assets. And for sponsors, industrial companies are often cyclical, so there is the opportunity to buy companies at a reasonable price as the economy accelerates, said Sanders, of Morgan Stanley.

“In the current market, what you’re seeing is that there’s a strong bid for the assets, prices are at fair valuations, and people have more confidence in the economy,” Sanders said. “If you see the economy improving, it’s a lot easier to get your head around how [industrial] companies are going to perform.”

Examples include JF Lehman & Co.’s acquisition of two groups that provide oil spill removal services and a manufacturer of industrial products from SEACOR Holdings Inc. for $97 million; and Aperion Management LLC’s acquisition of the municipal solid waste transfer station management and transportation business of Sprint Logistics LP. Among the more active investors in the sector was turnaround firm Platinum Equity LLC, which closed two platform acquisitions in industrials, including Keen Transport Inc., a Carlisle, Pa.-based company that transports heavy equipment.

“We can see in our own current portfolio, our industrial businesses across the board are performing much better,” said Carlyle’s Holt.

High technology was the second-most popular sector for investment by U.S.-based sponsors, the first time since the third quarter of 2010 that it was not the most active sector. It accounted for 35 deals, or 15.7 percent of the 222 deals closed by March 21. The sector produced three of the 10 largest deals closed in the quarter, including the top two: the $1.77 billion buyout SunGard Higher Education, and Permira Advisers Ltd. and Technology Crossover Ventures’s $1.5 billion buyout of enterprise software services company Genesys. (See table for other deals, and rankings for all sectors.)

Financing remained relatively modest, while purchase price multiples remained high in Q1. This suggests a cautiously optimistic market in which sponsors, generally speaking, still have to put up significant equity to close deals. Sources said equity checks across the market hover in the range of 35 percent to 45 percent of deal prices.

The average debt multiple for larger buyouts of companies with $50 million or more of EBITDA was 4.5x, compared to an average of 5.2x EBITDA for both the first quarter of 2011 and for all of 2011, according to Standard & Poor’s Leveraged Commentary & Data. The average debt multiple of buyouts of companies with less than $50 million of EBITDA was 4.1x EBITDA in the first quarter, compared to 3.4x EBITDA for the same quarter last year and 4.3x EBITDA for all of 2011.

The average purchase price multiple for large buyouts of companies with $50 more of EBITDA was 8.6x EBITDA, compared to 8.4x in the first quarter of 2011 and 9.1x for all of 2011. Purchase price multiples for companies with less than $50 million of EBITDA was 7.3x EBITDA, up from 6.5x for the same quarter last year but down from 8.2x for all of 2011, according to S&P LCD. Pricing for senior cash-flow loans for mid-market deals were typically LIBOR+525 basis points with a 1.50 percent floor and an issuing price discount from par of 98 to 98.5, according to Golub. A typical example is Huntsman Gay Global Capital’s acquisition of Citadel Plastics, with total leverage of 4.5x and a LIBOR floor of 1.50 percent for a $185 million financing package.

Platforms Lead The Way

The types of deals sponsors closed in the first quarter were roughly the same as those seen in 2011. Platform deals, or new acquisitions (which could include standard LBOs as well as carve-outs, take-privates and companies bought from other sponsors, but not add-ons to existing portfolio companies), accounted for most deals, with 130, or 59% of the 222 deals closed in the quarter, compared to 57 percent for all of 2011. This is a positive sign suggesting buyout firms continue to be confident enough to spend most of their time buying new companies, as opposed to building up existing investments.

Private equity-backed companies completed 90 acquisitions, or add-ons, accounting for 41 percent of the quarter’s deals, compared to 43 percent for 2011. Carve-outs were a popular deal type in Q1, accounting for 40, or 18 percent of deals; followed by sponsor-to-sponsor deals, with 28, or 13 percent of deals, and take-privates, with 5, or 2 percent of deals.

The most active sponsor overall was lower mid-market specialist The Riverside Co., always one of the most acquisitive firms, with at least 5 platforms closed as of March 21, including Eagle One Inc., a logistics services provider. The Carlyle Group closed the second-most control-stake deals, with at least four, including its acquisition of Ri Happy Brinquedos Ltda., a Sao Paulo, Brazil-based retailer of toys and games, for $289 million.

Turnaround shop Sun Capital Partners and Chicago’s Waud Capital Partners tied for the third most active buyer, with at least three platform acquisitions each. Thirteen firms, including Apollo Global Management, Grey Mountain Partners and Resilience Capital Partners, closed two platform acquisitions each.

Underscoring the perspective of several sources on the quarter is a sense that, barring unforeseen circumstances, the economy seems to have ditched the specter of a double-ditch recession and is indeed improving, which should help the LBO market.

“I don’t go around thinking the world has improved dramatically, but you have seen modest improvements in various segments of the economy,” said Reeve Waud, founder of Waud Capital. “That sentiment is important with respect to investing: if you think the world is getting worse, you’re going to be more defensive; if you think things are improving, then you’re going to be modestly positive.”