A long time ago in a galaxy far, far away, buyout firms led deals valued at more than $1 billion dollars on a regular basis. Now, for the first time since the late 1980s, G.P.s are returning to the era of their forefathers.
Buyout firms this year have either closed or announced six billion-plus deals that have a total value of $19.2 billion. This is more than the total for any full year since 1989 and puts buyout firms on a pace to match activity in the mid-1980s, when groups rang up between 10 and 15 billion-plus deals per year, often totaling more than $30 billion.
The sudden increase in mega-deal activity reflects either the maturity or excess of the buyout industry, depending on whom you ask. Some sources argue maturity because firms are becoming more established and are more responsible with the way they structure transactions; others say excess because, in order to invest capital more quickly, these groups are moving away from the size of deal that has made them successful.
In either case, G.P.s may have a more difficult time winning deals in the second half of the year as strategic buyers accelerate their activity to beat the Financial Accounting Standards Board’s elimination of pooling-of-interest for corporate mergers (BUYOUTS May 3, p. 15).
Buyout firms today also are casting a wider net than in the past in their quest for the once-elusive mega-deal beast. These groups-which 10 years ago would not have even considered a billion-plus deal that fell outside of the manufacturing industry-in the last several months have won auctions for financial services, communications, technology, retail and packaging companies, as well as hotel operators and waste haulers.
While the level of exuberance for mega-deals has heated up, bigger companies do carry proportionately larger price tags, and the higher multiples in this category often call for G.P.s to use a discerning strategic eye.
“There need to be synergies to make billion-plus buyouts work,” says Howard Lipson, a managing director at The Blackstone Group.
Examples of these synergies abound in the first half of 1999: For example, Welsh, Carson, Anderson & Stowe and Blackstone partnered to acquire Centennial Celluar Corp. for $1.8 billion (BUYOUTS Feb. 8, p. 12) in order to help expand the company’s coverage across more markets. Likewise, Blackstone teamed with strategic buyer TCI Communications in the $1.25 billion buyout of cable television company Bresnan Communications in the hope that they can increase revenue by introducing telephony and Internet access to its 660,000 customers (BUYOUTS Feb. 22, p. 1). Blackstone also teamed with Apollo Advisors to lead the $9.05 billion merger of trash hauler Allied Waste Industries with Browning-Ferris Industries. Although the firms hold only a minority interest in Allied Waste, its allegiance with the two companies could prove a boon when it comes time to exit the investment (BUYOUTS March 22, p. 1). DLJ Merchant Banking Partners and Greenwich Street Capital Partners also are co-investing in the merger.
Turnarounds Grow in Size
In a different, yet still synergistic vein, the recently announced agreement by Texas Pacific Group to acquire the semiconductor component group of Motorola Inc. for $1.6 billion (see story, p. 1) draws heavily upon TPG’s experience with its other portfolio companies in the technology sector, GlobeSpan and Zilog Inc.
Meanwhile, some firms leading other billion-plus deals opted to invest in underperforming companies. Apollo, Beacon Capital Partners, Rosen Consulting Group and Thomas H. Lee Co. partnered to acquire a minority stake in Patriot American Hospitality for $3.5 billion. Prior to selling that stake, the hotel operator and owner had overextended itself and was struggling to refinance its heavy debt load (BUYOUTS March 22, p. 1). In addition, Madison Dearborn Partners, in a deal that closed last month, has teamed with Tenneco to buy its ailing paper packaging business-now called Packaging Corp. of America-in a $2 billion buyout (BUYOUTS Feb. 8, p. 5).
This build-up phenomenon is a sharp contrast to the late 1980s when many buyout firms bought companies valued at more than $1 billion, stripped the assets and then sold the carcass.
To put this spate of activity in perspective, firms have announced or closed billion-plus deals with a dollar volume that is already almost 70% more than the $11.84 billion total in 1998.
To suggest the only reason firms are investing more in mega-deals is that they have raised more capital is simplifying the issue. However, fund-raising success does make more big deals possible, and buyout groups in 1998 raised a record $54.54 billion, 58% more than they raised in 1997 (BUYOUTS Jan. 11, p. 1).
Although there are now between 25 and 30 firms that can lead a billion-plus deal without a co-investor-the same number as a year ago-many of these firms are sitting on much larger war chests.
For example, Hicks, Muse, Tate & Furst Inc., E.M. Warburg, Pincus & Co. and Welsh Carson all have raised substantially larger pools of capital than they held at this time last year.
Also, there have been a few recent additions to the roster of firms that can play comfortably in the mega-deal arena. For example, Madison Dearborn invested $236 million of equity in the Tenneco division from its new $2.222 billion fund. The group’s investment represents 11% of the 1999 fund and fits nicely, size-wise, in the partnership. However, the deal would have been 26% of the $925 million fund the firm invested from 1996 through 1998, which would have made the investment more difficult to make.
G.P.s and L.P.s suggest that as firms raise greater amounts of capital they are left with two choices: To increase the size of their firm and find more deals of the size to which they are accustomed or to keep the staff they have and invest in bigger deals. This is based on the largely accepted theory that it takes the same amount of manpower to land a mid-market deal as it does to land a billion-plus buyout.
“You can do a larger deal without increasing staff size, so a lot of firms keep moving up the food chain,” says a G.P. who spun out of a large firm to make middle-market investments and who declined to be identified.
Other sources, however, see strategic advantages in keeping only a limited number of partners at a large firm so as not to dilute the brand-name aspect of the rainmakers. “One could argue that Henry Kravis sees more deals because people identify Kohlberg Kravis Roberts & Co. with Kravis, and that if his, or other firms, became too large they could lose their identity and culture,” says Jim Lane, managing director in Societe Generale’s merchant banking group.
The most common way firms today are investing in mega-deals is by partnering, and that trend is only expected to continue, sources say. More importantly, firms are showing more interest in partnering with strategic buyers on billion-plus deals.
The reasons for increased interest in partnering revolve around the difficulty of winning big deals, and the manner in which firms are planning to grow their investments.
Sources estimate the number of companies fetching more than $1 billion at auction is one-seventh the number of businesses selling for between $100 million and $1 billion, incidcating intense competition in the mega-market.
G.P.s Resemble Venture Capitalists
In the six deals of more than $1 billion announced or closed this year, groups partnered three times with other financial buyers-in Browning-Ferris, Centennial Cellular and Patriot American-and twice with strategic buyers-Tenneco in Packaging Corp. of America and Bresnan in TCI.
This is in sharp contrast with 1998, when financial buyers closed four of seven billion-plus buyouts without significant co-investors. Last year, Bain Capital invested in Domino’s Pizza, Hicks Muse acquired LIN Television Corp. and SFX Broadcasting, and KKR bought Willis Corroon Group plc all without the added buying power of co-investors.
“KKR & [Forstmann Little & Co.] don’t like partners, but the rest of us are starting to imitate venture capitalists and are sharing deals back and forth,” Mr. Lane says, adding that groups need to partner in order to reduce competition.
This also can sometimes mean partnering with a strategic buyer and taking a minority stake in a company. “When you’re comfortable with an industry and management and you have an influence on a company, you can live without being able to dictate policy,” Mr. Lipson says.
Some buyout firms also may need to partner because they are working at a disadvantage in mega-deal auctions, sources say.
Boards today look for buyers with recognizable names that will be able to quickly arrange financing. Fairly or not, these sellers do not believe every buyout firm that makes a billion-plus bid qualifies.
Investment bankers that shop these companies say firms like AEA Investors, The Cypress Group, Investcorp and Leonard Green & Partners have made serious bids in the last twelve months for billion-plus companies but came away empty handed.
“Many private equity firms do not have the infrastructure and brand-name recognition to land billion-plus deals,” says Ray Beier, a partner at PricewaterhouseCoopers.
The desire to partner does not have to do just with winning deals. There also is a practical side to partnering.
Many buyers that invest in mega-deals, like those that buy smaller companies, are looking to acquire add-ons. G.P.s that lead a $1 billion buyout themselves may have a difficult time infusing new capital in the investment, should it be required for external growth.
“You can do a larger deal without increasing staff size so a lot of firms keep moving up the food chain,
In spite of cutthroat competition at auction for large deals, some companies in industries that have fallen out of favor may be more competitively priced than their brethren. Boards at publicly traded mid-market companies in the health-care, industrial, pharmaceutical and retail sectors valued at between $600 million and $2 billion have not enjoyed the boom that large-cap companies in other sectors have in the public markets. As a result, some boards, after having waited a year or longer for their companies to rise in value, may now be willing to sell-potentially at a discount.
“The undervalued nature of mid-cap companies is causing more companies to be available at reasonable prices,” says David Spalding, a partner at The Cypress Group.
Another way firms are trying to reduce competition for larger deals is by traveling to the other side of the Atlantic.
Although only KKR has led a billion-plus buyout in Europe in the last 12 months-its $1.4 billion acquisition of Willis Corroon, a British insurance company (BUYOUTS Aug. 3, 1998, p. 8)-there may soon be several others, sources say.
Boards at European conglomerates increasingly are selling divisions that are priced at about $1 billion, sources say, ripe picking for LBO firms. European companies now are at the divestiture stage U.S. conglomerates were at five years ago.
Heavyweights like The Carlyle Group, Clayton, Dubilier & Rice, Hicks Muse and KKR recently have established offices in the U.K. and already are bidding on some less-than-modestly-priced divisions of European companies
While it still may be difficult for U.S. firms to buy companies without hiring local dealmakers, sources say, most of the U.S. firms shopping in the continent have hired G.P.s from Europe whom they believe have knowledge of the networks.
“The cultural differences will be minor because there will be German partners at KKR, and those people will know the environment in Germany,” says David Luttway, an investment banker at U.K.-based Schroder & Co. Inc.
Year 2000 Pooling Problem
Although G.P.s have been winning a great deal of billion-plus buyouts in the first half of the year, they may need to work harder to continue at their current pace.
Strategic buyers that were considering making an acquisition are more likely to execute deals in the next six months to take advantage of pooling-of-interest tax laws, sources say.
The Financial Accounting Standards Board last month took the first step to eliminating this accounting practice and sources predict the law will change in the next two years. Because of this, strategic buyers soon may pay higher multiples to facilitate mergers, and that could impact purchase multiples for all billion-plus companies. “I could picture a scenario where financial buyers get priced out of the market,” says Robert Willens, a tax and accounting analyst at Lehman Brothers.
Some strategic buyers that were interested in selling subsidiaries may now instead focus on corporate mergers, as time is of the essence.
“Strategics might be less inclined to sell orphans because those companies are not poolable in any case,” Mr. Beier says.
In the long term, however, this ruling could benefit G.P.s. “I believe that making it harder to do pooling will lead to more acquisitions being done for cash, and some of that cash will be raised from private equity firms,” Mr. Lipson notes.
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