Friday Letter: It's getting tougher out there

Non-traditional lenders are the only way to get big deals away, while the mid-market, long held up as evidence of the buyout model’s resilience, is looking trickier too. To make matters worse: vendors are battling with uncertainty.  

This week, lo and behold, produced a private equity mega deal: The Blackstone Group, Bain Capital and NBC Universal purchased US cable network The Weather Channel for approximately $3.5 billion (€2.2 billion).

This was notable for two reasons. A year ago, as the industry’s ambitions and appetites soared, commentators were wondering whether the definition of “mid-market buyout” would have to be stretched to include lower-end multi-billion-dollar deals. Today, Weather Channel is unlikely to rank as a mid-market buyout: courtesy of the credit crunch, $3.5 billion is the new $35 billion. In fact, Weather Channel has a decent chance of being remembered as the largest agreed private equity transaction in the United States this year.

Secondly, to finance the deal the syndicate needed to dig deep. Relying on banks – in this case Deutsche Bank and GE Commercial Finance – to underwrite even modest transactions on their own just isn’t enough today. The two buyout firms had to turn to their own hedge fund affiliates for funding. Bain brought in Sankaty Advisors, while Blackstone looked to GSO Capital Partners.

To be sure: some bank debt is still available, though not in spades. And we are certain to see more creative financing of this kind as buyout firms look for support.

Conventional wisdom has it that mid-market firms – in the traditional sense of the term – are not as constrained as their mega-fund peers. But they too are facing increasingly challenging condition.

Global buyout firm 3i’s chief executive Philip Yea told the press this week that the first three months of the year had provided “both investment opportunities and continued realisations despite the challenging economic outlook”. Yet it seems doubtful that the second quarter will have offered as much cause for cheer, even though high quality businesses have continued to come to market. 

For example: on Wednesday it was announced that DLJ Merchant Banking Partners had thrown a lifeline to the stalled auction for Education and Adventure Travel, a well-performing educational and activity travel business put up for sale by UK sponsor Bowmark Capital. The deal had been left in the lurch by the withdrawal of the leading bidder after its US parent had decided to pull in its horns.

DLJ saved weeks of work and snapped up a staple finance package from a Royal Bank of Scotland consortium of Lloyds TSB, Fortis and Ares Capital Europe for the £100 million deal. (Yes that’s right: it took four lenders to get this tiddler away.)

What this transaction highlights is that even a strong-performing business with plenty of potential runs the risk of a broken auction in the current environment. It seems inevitable that we will witness more deals run aground, unless vendors can afford to show the kind of pragmatism demonstrated by Bowmark, which even at a reduced price could still book a return of four times its original investment. Other sellers will perhaps not be so fortunate and as such will not chance their arms till markets improve.

Maybe it’s time to head to the beach.