Buyout pros have no qualms with today’s deal market. Even with about 1,200 private equity firms on the deal trail-and more on the way-general partners say that there is no shortage of attractive companies to invest in. And even though there’s more competition, the deep lending pool is ensuring that no buyout shop is parched for cash while jockeying for a deal.
Last year’s triumphant finish certainly made for this year’s quick start. We’ve already witnessed a total of 207 control-stake transactions close in the first quarter alone, representing a disclosed value of approximately $39 billion. Compared to the 215-plus deals that closed in the Q4 2004, totaling about $46 billion in disclosed values, 2005’s deal volume is already on par to facilitate another record-breaking year.
“This is an incredibly robust market. Banks are not as conservative as they were two years ago, or even one year ago. And if you believe that this is a cyclical market, and I tend to, I think we’re nearing the top,” says Robert Landis, a principal at The Riverside Company.
Classic LBOs for platform companies accounted for more than a quarter of total deals completed in the first quarter. Quantitatively, add-on acquisitions made up about the same number of closed deals, a sign that GPs-many of whom are in the fundraising market-may be putting more of an emphasis on shoring up their existing portfolios to take advantage of the seller’s market.
Driving deals on the buy-side is an amplified version of what 2004 had to offer. Funds are willing to look at larger transactions than they have in the past, sellers are looking at the prospect of executing transactions in a favorable environment, and increased leverage capabilities are enabling firms to go out and compete harder to win deals.
But even though the drivers are the same, on a quarterly basis, Q1 2005’s $39 billion start was a Goliath compared to the 117 deals-about $16 billion in disclosed values-that closed in Q1 2004. The largest transaction to close thus far in 2005 was the $5 billion Intelsat deal sponsored by Apax Partners, Apollo Management, Madison Dearborn Partners and Permira, closely followed by the $4.9 billion taking-private of electrical products distributor Rexel SA by Clayton, Dubilier & Rice, Merrill Lynch Global Private Equity and Eurazeo.
Compare those with the two front-runners completed in Q1 2004-Bain Capital’s $1.7 billion purchase of two Deutsche Bahn units and the $1.1 billion acquisition of Weetabix by Hicks, Muse, Tate & Furst-and it’s plain to see that things have been ratcheted up.
And while auctions have no doubt become a mainstay in private equity, no deal pro admits to simply waiting around for I-bankers to give them a heads-up on a process. “The death knoll to a private equity group is to sit in their offices and wait for the next auction memorandum from Wall Street,” says Daniel D’Aniello, a founding partner and managing director at The Carlyle Group. “You have to get out of your office and into the industry to create opportunities. And you make premium returns in this business by taking the right risks-the risks that your skill base can manage against.”
Multiples And Multitudes
The easy availability of large sums of debt is high on the list of defining characteristics of today’s deal environment, PE pros say. “It was almost as if a switch turned on at the beginning of ’04 where the lenders were back active in the market,” says Lincoln Partners Co-chairman and Managing Director Robert Barr. “And now, with even more competition, and lending multiples going up, the availability of funds from both banks and non-bank financial institutions is pretty prevalent-and they seem to be getting even more aggressing in terms of their lending.”
A blindingly obvious glimpse of this can be seen in the recently announced $11.3 billion taking-private of SunGard-led by Silver Lake Partners and backed by a caravan of six other private equity firms-in which JP Morgan Chase & Co., and four other lenders are facilitating an approximated $7.8 billion debt tranche.
“Looking at the deal market as a whole, I’d say leverage multiples of six-times EBITDA and higher have become an industry standard… I think there are certain companies today that are getting financed at multiples that are in excess of what they would have sold for on a total enterprise value three or four years ago,” says Jonathan Lynch, a senior partner at JPMorgan Partners.
To this, Carlyle’s D’Aniello breaths a word of caution: “The banks are, in some regards, offering more debt than is reasonably acceptable, given the standards of the past and looking into the future. Most private equity prognosticators would tell you that they expect returns to decline slightly in the future. This means there may be an impending squeeze between lower cash flows and rising interest rates.”
D’Aniello adds: “On the front end, available debt financing levels used to average 4x to 5x EBITDA; now they average 5x to 7x EBITDA. So people get lulled into that false notion that if you put a lot of debt on a company, you can add a lot of return to the equity underneath the debt. But what they’re failing to realize in many cases is the heightened risk. Using that much debt requires that you earn a lot more on your equity, but yet there’s more uncertainty that you actually can. We would rather earn a safe 20% to 25% return than a 30% to 35% return that’s under 7x or 7.5x leverage.”
In Q1 deals closed throughout the industry spectrum. But while opportunities abound across all of private equity’s bread-and-butter markets, e.g. manufacturing, chemicals and telecom, some specific sectors are being favored more than others, deal pros say.
Retail, for one, was a major force of attraction among the PE crowd last quarter. At least 12 retail deals were completed in the last three months and there are more to come, including the $8.8 billion (assumed debt included) buyout of Toys R’ Us by Kohlberg Kravis Roberts & Co., Bain Capital and Vornado Realty Trust.
“Right now retail is obviously on the forefront of most people’s minds. I don’t know if it’s a more attractive area for investment than the others, but it’s certainly one of the more active areas for investment,” said one buyout pro.
Successes like Bear Stearn’s turnaround of New York & Co. and the Sears/K-mart merger got people focused on creating value within retail, he said. Also, there is the notion that retail is over-stored and is ripe for consolidation that can effectively be accomplished in a private equity setting. And third, he said, “I think there’s a momentum factor in any marketplace-once you start turning over a couple of stones, people start prospecting of gold under others.”
Food, though more traditional among the PE crowd than retail, also saw a considerable amount of action in Q1. “I think that there is an inflationary bias going on right now-meaning that commodity prices are continuously getting higher-so there’s a conventional wisdom that suggests that the interest rates are going to go up. And I think food and food-related [investments] are more attractive in those kinds of climates than basic industrial type companies,” Riverside’s Landis says.
One Down, Three To Go
With more than 200 deals already completed and a surplus of 100-plus transactions pending-including the $11.3 billion SunGard deal, the $8.8 billion Toys R’ Us buyout and 16 others valued at $1 billion or more-things are just getting started in 2005.
There seems to be no dispute among buyout pros that this is a golden age for private equity. But just because times are good doesn’t mean they’re easy. No one competing for deals in today’s market says they are sailing at anything but full-steam.
“You can’t leave anything on the table to the extent you’re paying for property these days. You have to be aggressive, but you have to pick your spots. You have to know when you’re going to win and you need a solid understanding of who you’re competing for a property against,” said the deal pro who did not want to be identified, adding that the market will likely get more competitive as private equity moves further into the mainstream.
As far as the end of the market’s frenetic pace is concerned, those in the market say that slowdown is likely at least a year away.
“There is a cyclicality to the LBO market. We’ve already gone through two cycles. And arguably you could say we are in the third,” says Riverside’s Landis. “Of course if anybody could divine when the top will occur, they wouldn’t be in private equity, they would be retired now. But I think the case could be made that we’re approaching the nadir of the third cycle. But whether it ends in ’05 or ’06, and whether it’s a gentle touchdown or a hard landing, is going to be anybody’s guess.”