The days of the mega-buyout have seemingly been numbered ever since the collapse of Lehman Brothers. The writing was on the wall long before that of course – deals like the $33 billion buyout of HCA had started alarm bells ringing, long before the sub-prime crisis and then Lehman.
Larger deals have still been happening sporadically – the €2.3 billion acquisition of Securitas by Bain Capital and Hellman & Friedman last June, for example, or the $7.2 billion acquisition of a 60 percent stake in Samson Investment Company by firms including Kohlberg Kravis Roberts, which completed earlier this year – but on the whole, firms have steered clear of the type of transaction that came to dominate headlines during the boom period.
Why? Valuation has been a key problem – in a market heading south, sellers have generally been slow to cut their pricing expectations. The availability, and cost, of debt financing has also been a major barrier. Banks simply haven’t been willing to issue senior debt in the volume necessary to underwrite large deals, or at prices that sponsors would consider acceptable.
In addition, firms have grown increasingly risk averse. Perhaps cognisant of the reputational damage inflicted by high profile blow-ups like EMI, and having learnt the difficult lesson of over-leveraging in some cases, private equity groups instead hunkered down to focus on strengthening their existing portfolios. Some, in a bid to put at least some capital to work, made sporadic forays into the mid-market when opportunities presented themselves. Bigger ticket deals have been rarer than a sunny British day.
So what’s changed? Banking sources have indicated there’s growing interest in larger deals among sponsors and lenders alike. Many GPs have been driven to act by fast-approaching investment period deadlines – legal sources have spoken frequently of extension requests being tabled to LPs. The amount of dry powder, estimated at almost $1 trillion by Bain & Company in March this year, is also forcing sponsors’ hands. The Blackstone Group alone has $36 billion waiting to be spent, $16.4 billion of which resides in its private equity unit according to its Q2 results released this week.
Banks, although more circumspect than they were back in the boom, are willing to issue debt given the right quality of asset. Direct Line, with its reliably high cashflows, is a bank-friendly asset, sources indicate.
Valuations are also increasingly attractive, particularly when sellers are distressed. Direct Line, again, looks an absolute steal with its rumoured sub-£4 billion ($6.3 billion; €5.1 billion) price tag and operating profits of £454 million last year; RBS’ original asking price was nearer £7 billion back in 2008. It’s little wonder that firms including Apax Partners, KKR, BC Partners, Bain and The Blackstone Group are understood to be considering bids.
Some of those firms are also reportedly plotting joint offers, another feature of the heady days of the buyout boom. Though LPs are right to flag concerns over multiple exposure to the same deal via different funds participating in a syndicate, that’s unlikely to be as serious a concern as it was in the past, given investors have largely streamlined their relationships and are less likely to be invested in multiple funds with similar mandates. Consortium bids make sense as they allow firms to spread the risk, and the capital load. Given the higher equity component generally required in today’s market, that’s an important consideration.
So, valuations are (in some cases) more attractive and debt is available for the right assets. Private equity firms should grasp the nettle and do what investors back them to do: take (measured) risks, invest capital using reasonable amounts of debt, improve businesses and generate value. Studies have shown the best returns are delivered by deals done during downturns backed up by LPs’ own data, and more intriguingly, that big deals done during the boom have actually performed well on the whole. It’s time for the big firms, with big funds, to get back to doing big deals.
P.S. Private Equity International's inaugural Awards for Operational Excellence will take place later this year. Details, together with a submissions form, can be found HERE.