By the end of the second quarter, 1998 was poised to be an earth-shattering year of deals for buyout transactions. In late June, the private equity buyout world had already completed more than $27 billion worth of deals, nearly matching 1997’s year-end total of $28.728 billion.
Then came the “blip.” International debt troubles and a public market nosedive froze financing and threw a wet blanket on an otherwise sizzling deal market, particularly in the big deal arena. The third quarter slowed to $8.356 billion, and the fourth quarter saw less than $5 billion in deals, according to BUYOUTS and Securities Data Co.
Despite the financing troubles, though, 1998 still turned out to be by far the biggest deal year of the decade-$40.982 billion, compared with $28.728 billion in 1997. Mezzanine debt, tack-on financing and greater equity commitments stepped in to fill the void left by jittery senior lenders and a non-existent high-yield market. Still, the credit crunch left many in the private equity world wondering if the deal market would be able to return to the relatively brisk pace of the first half of the year.
Most general partners are predicting that 1999 will continue to show heavy deal activity and that the late-summer blip will be just that-the temporary slowdown of a mighty buyout machine fueled by unprecedented amounts of equity. With so much money looking for so many deals, they say, deal volume can only go up.
Much of 1998’s dollar value came from its relatively large number of mega-deals. Seven deals of more than a billion dollars made up about $11.84 billion of the closing numbers. By contrast, in 1997, a paltry four mega-deals yielded a total of $4.79 billion, a drop from $10.64 billion in 1996 among seven such deals.
The biggest deal of 1998 was Lehman Brothers $2.3 billion acquisition of coal producer Peabody Holding Co., which tapped a full 20% of Lehman’s $2 billion second fund. The firm bought Peabody from The Energy Group, which was forced to divest the coal company as a condition of its acquisition by Texas Utilities Co., a strategic buyer advised by none other than Lehman’s investment bankers. Limited partners were nonchalant about the possible conflict of interest (BUYOUTS June 22, 1998, p. 1).
Two of 1998’s mega-deals were actually holdovers from 1997’s feverish fourth quarter. The $2.018 billion acquisition of LIN Television Corp. by Hicks, Muse, Tate & Furst Inc. and Thomas H. Lee Co.’s $1.4 billion buyout of Fisher Scientific were inked in late 1997.
Two 1998 mega-deals were joint efforts, including the $1.5 billion acquisition of Regal Cinemas, when Kohlberg Kravis Roberts & Co. joined forces with Hicks Muse. Apollo Advisors could have rounded out the list had its team-up with strategic buyer Interpool to buy XTRA Corp., a lessor of freight transportation equipment, proved successful.
Cautious Lenders Spoil the Party
In the second half of 1998, lenders, particularly at the high end of the market, kept material adverse clauses within reach as market turmoil threw the country’s economic future into question. In the third quarter, for instance, not a single deal valued between $500 million and $1 billion closed, nor did any mega-deals, after the second quarter saw four such deals close.
General partners blamed the total shut-down of the high-yield market for the slow deal flow. “The last quarter was a fascinating one,” says Christian Oberbeck, managing director at Saratoga Partners. “We saw valuations go down, but the financing wasn’t there. The big deals could only be done with junk bonds. In the middle market, you had mezzanine [financing], and you could get a deal done. But if [the deal was] over a billion, you almost couldn’t do it.”
Indeed, the flow of mid-size deals was not as severly affected by the credit crunch, and still managed to show an increase over the same time period a year earlier. The second half of 1998 saw a total of $7.307 billion in deals valued between $100 million and $500 million close. This compares with $5.267 billion in mid-size deals in the second half of 1997, which includes the high-octane fourth quarter of that year.
In reaction, the third and fourth quarters also saw buyout firms that normally pursue large companies stepping into the middle market. Kohlberg Kravis Roberts teamed with Welsh, Carson, Anderson & Stowe to buy Medcath Inc. for $227.8 million in the third quarter. Welsh Carson, with a $3.15 billion buyout fund, also bought Centennial HealthCare Corp. for $292.1 million in the fourth quarter. Texas heavyweight Hicks Muse acquired L. Daehnfledt A/S for $48.9 million in the same quarter.
The popularity of mid-size deals may be a reaction to limited partners who are growing leery of the prices paid in mega-deals. “We’re seeing a bifurcation between large funds and small funds,” says Erica Bushner, a vice president at gatekeeper Wilshire Associates. “The big funds are having a hard time justifying their size.”
Many of the deals completed in the second half of 1998 were facilitated by mezzanine financing, which is having a heyday in the wake of more cautious senior lending. Thomas Leissl, a vice president at BHF-Bank Aktiengesellschaft, sees this trend continuing into the new year. “The next six months will be relatively the same as in November and December. Pricing is high, and leveraging above four times EBITDA is tough,” he says. “Senior lenders are maxing out at four, but then mezzanine comes in. There are still a lot of people out there desperate to do deals.”
Kevin Callaghan, managing director at Berkshire Partners, predicts a gradual loosening of the capital markets, but is not expecting the heady days of the first half of 1998. “I don’t think we’ll get back to the frothiness exhibited in May, June and July,” he says.
Jon Tietbohl, a managing director at New York investment bank Tucker Anthony, says banks will continue to show caution when it comes to lending at higher multiples. He says lenders who were once lending on advance rates of EBITDA multiples of five have now moved their target rates to the low fours and high threes.
Despite a relatively lackluster fourth quarter, general partners, lenders, and investment bankers predict a busy, if jittery, year in 1999.
Chief among reasons to expect a heavy deal flow, they say, is the amount of liquidity remaining in the buyout market. “It’s still a great time to be a seller,” says Stephen Cummings, an investment banker at Bowles Hollowell Conner & Co.. “There are still a lot of buyers out there. I definitely think that we’ll see a lot of activity in the first quarter. The deals that were delayed in the fourth quarter are going to happen in the first quarter.”
Raymond Beier, a mergers and acquisitions adviser with PricewaterhouseCoopers, echoes these predictions. “There’s a lot of pent-up demand. The marketplace is poised to come out of the starting block with a huge effort.”
Mr. Beier adds that finding financing will continue to be a chief concern for dealmakers. “Some of our clients are looking, but the subordinated debt tranche is not there,” he says. “It seems like it’s coming back, but it’s hard to say.”
Many market participants see some softening of prices in the coming year, but not enough to warrant any celebrations in the buyout world. “In August and September, we all thought there would be a break in valuations, but that didn’t happen,” says Thomas Hicks, a founding partner at Hicks Muse.
“There’s still a lot of money looking for deals,” says Dennis Costello, chief investment officer at Advent International. “And strategic buyers are back in the marketplace, and that is countering the downward pressure [on prices].” Mr. Costello adds that he has seen purchase price multiples “all over the map,” but generally between seven and nine times EBITDA.
“We’re getting deals at decent prices,” says Harvey Werthiem, a partner at Harvest Partners. “Not cheap, but decent prices. I see that moving into the next quarter. The smaller deals are cheaper, and as you move into the larger, more mainstream deals, it gets more expensive.”
Mr. Wertheim says he has recently seen prices in the range of five-and-a-half to seven times EBITDA, as opposed to multiples of seven to nine he saw before the capital markets turmoil.
Few G.P.s feel that one particular sector is going to be more active than any other. But some sectors, like energy, are getting unprecedented attention from mainstream buyout firms. As noted earlier, Lehman Brothers’ big deal of the year was a coal company. Also, Hicks Muse has caught the oil bug. In the fourth quarter the firm agreed to purchase Coho Energy for $250 million and Triton Energy for $350 million.”Oil and gas is getting decimated worse than it has in the last 25 years,” Mr. Hicks says. “We’re going to see massive consolidations in the oil and gas sector as oil companies dump properties.”
Mr. Hicks also sees opportunities abroad, particularly in Latin America, a region he feels has been treated unfairly by lenders. “The capital markets treat [Latin America] as if it were Indonesia,” he says.
Many of the larger U.S. buyout firms also are showing increased interest abroad, particularly in Europe. Hicks Muse, Clayton Dubilier & Rice Inc., E.M. Warburg Pincus & Co., The Carlyle Group and Texas Pacific Group all will have offices in London this year, and KKR is pre-marketing a European fund.
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