Industrials, Carve-Outs Dominate Cautious Market

The year also saw a substantial increase in deals in the industrials sector and an uptick in carve-outs. This suggests sponsors are betting heavily on an economic recovery, while also taking advantage of the desire by corporations, on surer footing following the downturn, to shuffle portfolios to focus on core businesses. 

U.S.-based sponsors and their portfolio companies closed 1,178 control-stake acquisitions globally in the year as of Dec. 10, with a disclosed deal value of $93.26 billion. With two weeks left in the year at press time, that was already a slight rise from the 1,170 deals closed in 2011, though still a 23 percent drop from the $121.3 billion in disclosed deal value for that year. Sponsors had closed 230 deals with a disclosed deal value of $27 billion in the fourth quarter as of Dec. 10; that compares favorably with the 322 deals with a disclosed deal value of $22.6 billion closed in the third quarter, and the 317 deals with a disclosed deal value of $34 billion in the fourth quarter of 2011.

Surprisingly, the 1,178 deals closed as of Dec. 10 is only 27 percent less than the 1,605 deals closed at the peak of the market, in 2007, a difference that will narrow once 2012’s final numbers are tallied. There were 156 deals pending as of Dec. 10, with $41.54 billion of disclosed deal value.

But the difference in deal value is immense, with the $93.26 billion in disclosed deal value so far this year still 84 percent less than the $594 billion in disclosed deal value in 2007. This suggests that lenders remain cautious following the buyout boom, though deal financing was more attractive for sponsors in 2012 than in any year since the downturn.

Average debt multiples for middle-market companies with EBITDA of $50 million or less, for example, reached 4.9x EBITDA in the fourth quarter, the highest average since 2007, according to S&P Capital IQ Leveraged Commentary & Data.

To find more comparable precedent for today’s deal market, one has to look to the pre-buyout years such as 2005, when sponsors closed 1,088 deals with a disclosed deal value of $170 billion.

“2012 was generally flat relative to 2011, which was a reasonable uptick from 2010, and certainly up from 2009,” said Seth Meisel, a managing director with Bain Capital LLC, which closed at least four platform acquisitions this year. “The question now is: What is the new steady state? What’s the new level that we should expect on an annual basis for deal volume?”

Industrials Ascendant

The industrials sector, which has seen a steady increase in activity in recent quarters, solidified its status as the most attractive sector for LBO activity after a prolonged period in which the high technology sector took the lead. High technology came in second place, with 189 deals, which is roughly flat from the 185 deals closed in that sector by this time last year, when it was the most popular sector (see chart for detail).

Sponsors closed 217 deals in the industrials sector, a substantial increase of 82 percent over the 119 deals closed n the sector by this point in 2011. Examples include Bain Capital’s agreement to buy power tool maker Apex Tool Group LLC for $1.6 billion, and TPG Capital’s $1 billion buyout of FleetPride Inc., a wholesaler of heavy duty truck parts.  

Sources attributed the increased interest in the sector to two main reasons. For one, fears of a double-dip recession in the United States have largely disappeared as a recovery has become increasingly apparent, and concerns with the sovereign debt crisis in Europe and a slow-down in China’s economy have eased somewhat. This gives sponsors more confidence to buy companies in the industrials sector, which tends to be more cyclical.

Meanwhile, many corporations coming up for air after the recession are re-assessing their portfolios as they plot their future. Examples abound, including Bain Capital’s agreement to buy Apex Tool from Danaher Corp.;  Clayton Dubilier & Rice’s $1 billion purchase of a 51 percent stake in WilsonArt International, a manufacturer of decorative surfacing products, from Illinois Tool Works Inc. as part of the seller’s plan to jettison slower-growing businesses; and Platinum Equity LLC’s $750 million acquisition of logistics services provider Caterpillar Logistics Services Inc. from Caterpillar Inc. as part of the latter’s “increased focus on the continuing growth opportunities in its core businesses,” as the company stated in a press release.

No less than five of the 10 largest pending LBOs are carve-outs, including The Carlyle Group’s agreements to buy DuPont’s coatings business for $4.9 billion and Hamilton Sundstrand’s industrial business for $3.46 billion.

“If you’ve made it through the cycle and your business is well capitalized, the next value creation is to re-evaluate your core business lines and make sure you’re focused on them and maybe that leads to pruning non-core assets,” said Bill Sanders, global co-head of the financial sponsors group at Morgan Stanley.

These opportunities should continue. For example, in November, Siemens announced it would look to sell its water technologies business, and Emerson Electric Co. said it would explore options for its embedded computing and power business as the electric products maker undergoes a strategic restructuring. “We’re optimistic that [strategics] will lead to some attractive deal opportunities,” said Meisel of Bain Capital.

Not surprisingly, the number of carve-outs completed by sponsors in 2012 increased from that seen in 2011. Carve-outs comprised 20 percent of the deals closed as of Dec. 10, compared to 16.7 percent in 2011. 

Overall, deal types were consistent with that seen in recent quarters and years. New platforms accounted for the majority of deals, comprising 58 percent of the 1,178 deals closed in the year. Sponsor-to-sponsor deals comprised 15 percent of the closed deals (see chart for detail).  

Leverage Increases, Deal Multiples Steady

Average leverage multiples for large and middle-market companies reached their highest levels in recent memory, while purchase price multiples and equity contributions remained consistent.

“Great companies were available at reasonable prices,” said Peter Clare, co-head of U.S. Buyouts for The Carlyle Group. Clare’s team completed six buyouts in the United States, with an average purchase price multiple of 8.4x, he said.

Debt multiples for mid-market companies with $50 million or less averaged 4.5x EBITDA for all of 2012, its highest annual level since 2008. In the fourth quarter, the average increased to 4.9x EBITDA, the highest it’s been since the peak of the market in 2007, when deals in this category averaged 5.6 EBITDA for the year.

The multiple has slowly risen from its bottom of 3.3X EBITDA for 2009, according to S&P Capital IQ. Average purchase price multiples for mid-market companies, meanwhile, fell to 7.6x EBITDA, down from 8.2x EBITDA and 8.4X EBITDA in 2011 and 2010, respectively. Senior cash-flow loans in the middle market tended to come in around Libor+500 with a floor of 1.25 percent, according to Lawrence Golub, CEO of lender Golub Capital. Equity checks averaged 41 percent of the purchase price for mid-market deals, an increase of one percent from 2011, according to S&P Capital IQ.

Debt multiples for buyouts for larger companies with EBITDA of more than $50 million averaged 5.2x EBITDA, the same as 2011, though they ticked up to 5.4x EBITDA in the fourth quarter. That is the highest level since the peak of the market in 2007, when debt multiples for such deals averaged 6.2x EBITDA. Purchase price multiples for large deals, meanwhile, also dropped a bit, averaging 8.8x EBITDA in 2012, compared to 9.1x EBITDA in 2011 and 8.5x EBITDA in 2010, according to S&P Capital IQ. Equity checks averaged 37 percent of the purchase price for large deals, an increase of one percent compared to the previous year.

Among the more highly leveraged deals were GTCR Golder Rauner’s buyout of Camp Systems International Inc., a provider of Internet-based aviation maintenance systems, for $675 million, which featured total leverage of 7.5x EBITDA; and Kohlberg Kravis Roberts & Co.’s agreement to buy property and casualty insurance provider Alliant Insurance, which features total leverage of 7x EBITDA, according to S&P Capital IQ.

A Rush To The Finish Line

The pipeline of deals as of Dec. 10 portends a hectic finale, a common year-end occurrence that many sources said was enhanced by looming tax increases, notably including capital gains, in 2013.

The rush to get deals done had forced some sponsors to get creative. For example, to placate the seller in a pending sponsor-to-sponsor deal at press time, the buyer invited the selling firm to sue it for the amount lost due to increased taxes should the deal not close by year-end, said Rob Brown, managing director and co-president of North America for Lincoln International, which was advising the seller.

“There’s much more pressure to get done by the end of the year,” said Brown, who added that he had never worked on a deal with such an arrangement.

The rush to get deals done by the end of the year created a backlog of product in the financing market, giving debt buyers more choices and forcing some companies to pull debt offerings while pricing on others flexed up in recent weeks, sources said. For example, in mid-December, pricing on a $1.45 billion six-year first-lien loan that RedPrairie Corp., an enterprise software provider backed by New Mountain Capital, launched to help finance an acquisition increased to Libor+550 with a 1.25 percent Libor floor after initially pricing at Libor+475 with a 1.25 percent Libor floor, according to Thomson Reuters LPC. And, World Kitchen, backed by Oak Hill Capital Partners, and Citadel Plastics, backed by Huntsman Gay, pulled debt offerings of $275 million and $271 million, respectively, to fund refinancings.

“Arrangers thought the seals are barking, so let’s feed them more fish,” said Golub, who was not referring to a particular deal. “Unfortunately, some were structured to be too aggressive, and what’s worse, we’re in a market in December where not every deal that wants to close is going to close, because loan buyers have more loans to look at than they have time to work on.”

Looking ahead, sponsors expect a slow first quarter following a frenzy of activity in the fourth quarter. Beyond that, many expect 2013 to settle into a fairly promising buyout market.

 “The conditions that made it attractive to buy companies in 2012 all continue in 2013,” said Clare, of Carlyle Group. “Prices will stay reasonable and not get overheated, and combined with a more positive view on U.S. economy and a low cost of debt, that makes 2013 an attractive buying market.”