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Sponsors Eye Cyclical Plays

Buyout firms are expressing more interest in cyclical sectors such as industrial and retail with an eye on bargain deals at the outset of an economic recovery, bankers and buyout pros told Buyouts.

“The perspective is there’s been a pretty strong rebound in those areas, but we’re in [the] early stages of economic expansion so companies are still selling off a lower earnings basis,” Mike Hogan, a managing director for the mid-market investment bank Harris Williams & Co. told Buyouts. “Therefore it’s an attractive time to buy in those industries.”

The interest in the industrial sector is also heightened by a weak dollar, which makes it more expensive to buy imported goods and puts U.S. manufacturers in a more competitive position, Hogan said. A strong financing market is also bolstering sponsor nerves to buy companies in these sectors.

Recent examples include the May 3 agreement by Berkshire Partners and OMERS Private Equity Inc. to buy Husky International Ltd., an Ontario-based supplier of injection-molding equipment and services to the plastics industry, for $2.1 billion.

The Blackstone Group, in a recent real estate play on the trend, reportedly bought about $600 million of debt on a group of industrial warehouse properties called CalWest with the aim of gaining control of the buildings. Blackstone is increasing its stake in warehouses and distribution centers while the industry “remains a cheap sector,” Steve Frankel, an analyst with Green Street Advisors, told Bloomberg.

Several firms that have traditionally targeted the industrial sector also seem to be ramping up their activity. Sentinel Capital Partners in April bought Chromalox Inc., a Pittsburgh, Pa.-based manufacturer of commercial and industrial electric heating products and solutions. And in January the firm bought Chase Industries Inc., a Cincinnati, Ohio-based maker of heavy duty doors for uses in industrial and retail settings.

“Historically it’s the consumer that has been [in] the vanguard of driving recoveries in the U.S.,” Sentinel Capital Founder David Lobel told Buyouts. “But in current market, with so much unemployment, the consumer has not been leading the recovery.”

Instead, Lobel said, many industrial companies that saw a 30 percent, 40 percent or even 50 percent drop in sales during the downturn have seen a rebound of about 20 percent in the last year.

“If your sales were down 40 percent and they’ve bounced back 20 percent in a year, that’s what you call robust,” Lobel said. “We’re seeing a very fast spring-back, and if you can buy now, you can still participate in that spring-back.”

As of May 11, U.S. buyout firms had completed or agreed to 32 control-stake deals globally with $1.7 billion in disclosed deal value in the industrial sector, which comprises aerospace and defense, automotive and components, building and engineering, machinery and other sub-sectors, according to Thomson Reuters, publisher of Buyouts. With about half the second quarter still to go, that amount of disclosed deal value is already close to levels seen in the fourth quarter of 2010—the most active quarter for sponsors across all sectors in recent years—when there were 64 deals with a disclosed deal value of $2 billion.

Buyout shops certainly don’t have free reign over the opportunity, however. In many cases they’re facing competition from corporations and other strategic buyers, which have more than $4 trillion in cash available for deals, according to a January report by the United Nations Conference on Trade and Development. Case in point: Kohlberg Kravis Roberts & Co., The Carlyle Group, TPG, Cinven and Advent International are all battling against American companies including Eagle Materials and U.S. Gypsum to buy the plaster business of French building materials company Lafarge, according to sister news service Reuters.

Though the consumer sector seems to be lagging in the recovery, Lobel of Sentinel Capital said his firm is eyeing deals with confidence that the recovery will eventually gain momentum there too.

To that point, Jeff Bunzel, a managing director at Credit Suisse, said at the Buyouts New York conference late last month that he’s seeing heightened interest among sponsors in retail for cyclical reasons. And Hogan said Harris Williams’s retail team is seeing more interest from buyout shops.

Among the most aggressive firms on this front has been Leonard Green & Partners, which abstained from buyouts for more than two years after the financial crisis. So far this year, the Los Angeles-based shop has bought preppy retailer J. Crew Group Inc. and crafts retailer Jo-Ann Stores Inc. It’s also reportedly trying to buy 99¢ Only Stores and BJ’s Wholesale Club, which Apollo Global Management is also reportedly interested in.