September 11 Attacks Alter Buyout Market Landscape

Any American who last month uttered the old Chinese curse “May you live in interesting times,” is probably biting their tongue now. No one needs reminding these are indeed interesting times, least of all private equity professionals.

Despite the hard hit to certain industries especially those related to travel buyout players are finding good opportunities in the disarray of the economy. Though it’s difficult to benefit from such misfortune, as it turns out, Sept. 11, in many cases, shocked sellers into the realistic valuations they were unwilling to accept prior to the attacks. “Business owners are having to adjust their valuation expectations to reality. So the idea is: Well, do we go ahead and bite the bullet now, and sell at a lower valuation, or do we wait and see if [the sellers’ market] is going to come back?'” says Brown Glenn, a vice president at Dallas-based investment bank Allegiance Capital Corp. “I don’t see a lot of people holding out six months waiting for valuations to come back.”

Not surprisingly, when Allegiance Capital took its weekly informal poll last week, “a great number” of business owners said they do not expect the market to recover quickly, Glenn says.

The Scapegoat

As most private equity players are ready to point out, the U.S. was well on its way to troubled economic times, before tragedy struck. Travel-related industries were already walking a thin line before Sept. 11 took them down even further. Like anytime people and companies face tough economic times, cutbacks are inevitable and one of the first expenses to go is unnecessary travel. “I think the handwriting was largely on the wall for the lodging industry because they live and die based on the business traveler,” said Allegiance’s Glenn. “Ditto the airlines because the business traveler makes much greater margins available to them than weekend public travel. Ditto the car rental companies.”

Still a number of private equity firms are faced with what to do with their existing investments in travel related industries. So far this year, at least five firms made investments in travel related businesses.

In May, Lafayette Investment Fund purchased Wyndham Jade, a provider of corporate travel management for an undisclosed value. The next month, Odyssey Investment Partners took ownership of Champion Aviation Products, a manufacturer of igniters for turbine engines used in commercial and regional transports, as well as in corporate jets and military aircraft, for $177.5 million.

Boston Ventures in August purchased Cahners Travel Group for an undisclosed price. The travel group publishes several travel publications and directories for business travel. Crescent Capital in August purchased Cirrus Industries, a designer and manufacturer or personal aircraft, for $143 million.

The outcome for these companies and their investors is still yet to be seen, but if the lodging industry is any indication, they may not be the highlight of these portfolios.

Hotel real estate investment trusts (REITs) already were feeling the pinch of a slowing economy before the attacks, but now analysts are expecting much sharper revenue decreases for the year.

In a sign of the turbulent times, before and after Sept. 11, hotel owner FelCor Lodging Trust abruptly ended its cash and stock deal to buy MeriStar Hospitality Corp., a major hotel REIT that has a joint venture with Oak Hill Capital, the private equity vehicle for Texas’ Robert Bass. The official word came in the days after Sept. 11, after the recent stock market slump made it too expensive for it to go ahead with the deal based on its original terms.

The same week, London-based Six Continents PLC broke off long-running discussions to buy Wyndham International Inc. from Apollo Advisors and Thomas H. Lee Co., citing adverse financial conditions.

“I get calls every day about hoteliers wanting to do deals, but the question is, who’s going to buy these assets?'” said Sumner Baye, president of the Hotel Network, a New York-based consultancy and broker. “The boutique hotels with the big loans will struggle when their mortgage comes due.”

Most sources noted that since the attacks, within their firms there are certainly more professionals conducting meetings through conference calls and video-conferencing than before.

The upside to the sudden sharp change in some spaces is that certain industries are finding new ways to survive. Basic manufacturing businesses, as well as service businesses, are coming more into line with buyers’ expectations. Other industries, particularly those related to security and construction, are seeing private equity firms flocking to them, hoping for a piece of the action.

So, deals are getting done in spite of the state of the country, and they’re not too shabby either. On Sept. 20, Wind Point Partners’ portfolio company Pacific Cycle acquired Schwinn/GT for $86 million in a deal that was hardly disrupted by the Sept. 11 attacks. Also, Clearview Capital LLC wrapped up its purchase of American Furniture Manufacturing Inc. for $36 million on September 21.

James Andersen, co-managing director of Clearview Capital, says American Furniture is in a good position to get through this period unscathed. “It’s business as usual for this company,” he says. “American Furniture continues to grow rapidly. Frankly we’re having a little trouble just building out fast enough to support the demand that’s out there.”

ICV Capital Partners LLC, a New York-based private equity firm, may have taken the prize, however, for most resilient company acquired in recent weeks. The firm closed a deal September 13, taking a majority stake in Sterling Foods Inc., a shelf-stable bakery products producer, for $35 million. The kicker is that not only is Sterling in the food industry, which will likely feel only minimal impact from current events, but one of the company’s main customers is the U.S. military. Therefore, the company is seeing considerable growth as its products are being sent to troops overseas and are being included in the humanitarian food drops over Afghanistan.

So while Sept. 11 has quickened the pace of the downturn in some industries, it is possible that many of the economic pitfalls seen now would have happened eventually, regardless. “One might argue that, if anything, the Sept. 11 attacks might have urged the Fed to be a little more loose with monetary policy than it might otherwise have been,” says Glenn. “Cheap money is great, but if your earnings prospects continue on a downward path than that doesn’t really get you all that much.”

Still, in the buyouts market, the troubles of finding the leverage to complete a deal without return-damaging percentages of equity are no less difficult. High yield is all but gone, and banks are thinking twice about lending to financial buyers who may join the long list of those defaulting on existing loans. “There are lots of healthy companies out there that are good candidates for new credit,” says Ken Kencel, co-head of RBC Leveraged Finance Group. “But lenders are going to be cautious about which industries they’re going to lend to and be more selective about who they think the winners and losers are.”

Gold Rush

Douglas Newhouse, a managing partner at Sterling Investment Partners says that Sterling had been anticipating a downward market for the last two years. “We were premature in that assessment,” he says. “So the kinds of businesses we have invested in over the last couple years have been fairly stable kinds of industries with necessary products and services.”

But Sterling isn’t just sighing with relief and waiting it out. Newhouse says the firm is eager to get its hands into the growing number of downtrodden companies. “I’m much more interested in businesses that have been hurt economically and are available at greatly reduced valuation levels,” he says. “That’s something we haven’t seen since the early 1990s.”

Other firms, including Texas Pacific Group, have not missed a beat, and are continuing to pick up divested assets from large corporations. The Dallas-based firm this month agreed to buy E.ON AG’s 70% stake in MEMC Electronic Materials Inc. for $150 million. TPG also agreed last month after the attacks to purchase Telenor ASA, Norway’s telephone directories, for approximately $666 million.

“You’ve got a lot of sectors that are really overbuilt – certainly the fiber optic-, telecom-related sectors and broadband-related sectors,” says Allegiance’s Glenn. “A tremendous amount of money has been spent in those sectors and it’s probably overspent. And it’s going to take a long time to suck up that capacity.”

Lock Down

Immediately after the attacks, the first step for private equity firms, sources say, was to reevaluate their portfolio companies and determine which ones would need help and which ones were susceptible to problems relating to the attacks. “We were immediately focused on any business that we own where security is an issue,” says Sterling’s Newhouse. One of Sterling’s portfolio companies came to mind right away Kenan Advantage Group, a transporter of gasoline throughout North America. “Obviously, in that situation we spent a tremendous amount of time right after the attacks, and are continuing to do so, on security issues.”

Alan Deane, vice president of business development at Foundstone, a computer security company, says that after the attacks on Sept. 11 there was a clear increase in interest from private equity firms in Foundstone’s services. “A lot of financial institutions out there are looking to determine if they are vulnerable,” he says. “So we’re doing a lot of testing and assessing and looking for those open windows and unlocked doors.”

Christa Fanelli can be contacted at: