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The Answer Is Private

What kind of buyers and sellers made the greatest strides in deal-making for 2004?
Tim Reason, CFO Magazine
January 1, 2005

Kmart-Sears may be the big-name deal of the year, and JPMorgan Chase-Bank One may boast the biggest ticket price. But the big news in acquisitions was definitely private equity. That's because last year's strong M&A recovery — which by December totaled $664 billion, 19 percent higher than in all of 2003 — reflected a heavy concentration of deals involving major nonpublic sellers and buyers.

Leveraged buyouts alone reached a 15-year high, accounting for nearly one-tenth of 2004 deals in terms of value. Among the billion-dollar-plus LBOs: Cox Communications; Metro-Goldwyn-Mayer; the Loews, Cinemark, and AMC Entertainment theater chains; PanAmSat; and the Texas Genco Holdings unit of CenterPoint Energy. But small and midsize domestic private-equity (PE) transactions helped boost LBO volume to a record $64 billion. And that's not counting PE sales or the initial-public-offering market, which PE sellers dominate.

Private buyers like Blackstone Group, The Carlyle Group, Apollo Management, and Kohlberg Kravis Roberts (KKR) expect their participation in overall dealmaking to increase sharply again this year, boosted by overflowing coffers and the recent move toward the formation of PE consortia.

And a push among private-equity firms to invest or cash out existing funds is driving up deal prices and making secondary buyouts — in which one fund buys from another — increasingly common. Last July, for example, Apollo purchased Borden Chemical from KKR for $1.2 billion. And through last August, Thomas H. Lee Partners LP had done six straight deals with other PE firms. "There's so much private-equity money out there, we are creating our own little market unto ourselves," says Kevin Landry, CEO of Boston-based TA Associates.

Dealing with consortia of buyers may take some getting used to, but publicly held sellers like CenterPoint don't seem to mind. "I don't know what went on behind the scenes," says CFO Gary Whitlock of his Texas Genco negotiations with GC Power Acquisition LLC, a company formed by Blackstone, KKR, Texas Pacific Group, and Hellman & Friedman. "But in our discussions with them, it looked like we were dealing with one [buyer]."

"A Good Time to Sell"
Since the tech-market bubble burst four years ago, economic factors have kept many publicly traded firms out of the acquisition market, and left them looking to shed businesses instead. For a public company, "it's a good time to be a seller," says Josh Harris, founding partner of Apollo.

That is part of the recipe for the rising share of activity by PE firms. But another factor is the looming expiration date for many of the huge five-to-seven-year funds raised in 1999 and 2000. Thanks to the subsequent economic bust, PE companies are sitting on vast amounts of capital they have yet to invest. That overhang puts them in the mood to do deals on both sides of the table — acquisitions to employ their remaining funds, and asset sales to boost returns before the funds close.

Investors, moreover, are clamoring for a chance to participate in new funds. Even though the largest PE funds have lowered their expected internal rates of return to about 20 percent on average, PE funds still are seen as a far better bet than stocks and other asset classes. Says TA's Landry: "Everyone in the private equity business knows that as soon as they invest the fund they have now, they can go out and raise a fund that is 50 to 100 percent larger."

Burgeoning debt markets also are heating up the activity, notes Hamilton E. James, Blackstone's vice chairman. When Blackstone bought TRW Automotive in 2003, the entire $4.73 billion price tag (a mix of debt, equity, and other financing) represented 4.7 times TRW's EBITDA (earnings before interest, taxes, depreciation, and amortization). Now, says James, the debt portion alone for deals involving more-marginal auto suppliers than TRW routinely amounts to 5 and 5.5 times EBITDA."

And there's more where that came from. "Hedge funds are moving fast and hard into the debt arena," says Stephen Boyko, an attorney in the Boston-based PE practice at Proskauer Rose LLP. "That's driving pricing down on the debt slice."

Little wonder that private equity has expanded into the largest M&A deals. "The competition in the midmarket for buyouts is intense," says James. And "the search for value is driving the biggest firms and funds up-market."

The successful consortia behind some of the largest private deals of the year — like MGM's sale to Sony through Texas Pacific Group and Providence Equity Partners, or the buyout by KKR, Carlyle, and Providence of satellite company PanAmSat — are challenging conventional wisdom in the PE world.

"If I had my way, we'd just go out and raise a huge fund and not deal with a consortium," concedes James, who, despite Blackstone's participation, sees going solo as a more efficient way to do a deal.

Sellers and their investment-bank advisers have some reservations about the rise of the consortium deal, too, worrying that it may reduce the total number of competitors in an auction. But their concerns are fading as deal-making picks up, actually boosting the competition in deals that once would have been too large for any but strategic players.


The Return of the Roll Up?
In the view of CenterPoint CFO Whitlock, sellers may actually find PE consortia more responsive than strategic buyers. "I think boards of public companies tend to be cautious and more risk averse," he says. For a public company, he says, any problem that may crop up during the deal can provide "a nice excuse to say, 'I need to check with the board.' "

That caution persists despite the upswing in public-company M&As that began last year. "Logically, the time for companies to buy cyclical businesses is when things aren't going well," says Apollo's Harris. "But that really isn't how it works." With stock values still low, companies have less cheap currency for deals. And while the average cash position at Standard & Poor's 500 industrial companies is more than double the level in 1999, many companies continue to eschew acquisitions in favor of strengthening balance sheets or using buybacks to pump up share values. And the negative effect of acquisitions on credit ratings remains a concern.

Then there's the Sarbanes-Oxley Act. "Sarbanes-Oxley has created a big disincentive for being public. And it's not just Sarbanes-Oxley. It's an unforgiving market where a company that stumbles is punished heavily," according to Blackstone's James. In contrast, taking a company private allows Blackstone and other private-equity firms to make changes out of the limelight.

Harris says Apollo "thought it would be easier to grow [Borden Chemical] as a private company." Sure enough, just three months after going private, Borden was able to acquire German resin manufacturer Bakelite AG.

Apollo has several chemical companies in its portfolio, including businesses and product lines from Kingsport, Tennessee-based Eastman Chemical Co. and the epoxy-resin business of Shell Chemicals. Such industry concentrations are common among PE firms, suggesting to some the prospect of a return to the roll-up approach to acquisitions. Not surprisingly, PE participation is heavy in such areas as power generation, communications, and movie-theater chains, where consolidation is needed, but where shareholder skepticism inhibits public-equity deals.

Strategic, Financial, or Both
Some might even argue that, given CEO Edward Lampert's 52.6 percent control of Kmart Holding Corp., his purchase of Sears, Roebuck and Co. was a form of private-equity deal. Certainly, retail is ripe for consolidation. And there can be no doubt that the $1.2 billion sell-off of Target Corp.'s Mervyn's stores was largely a PE transaction.

CenterPoint's Whitlock notes that "there were fewer regulatory issues" facing the GC Power consortium for the Texas Genco unit — notably questions about concentration of market power — compared with the questions raised for the Texas-based utilities that bid.

Of course, all potential buyers faced some regulation, particularly related to the six months or so it will take the Nuclear Regulatory Commission (NRC) to approve the transfer of Texas Genco's nuclear-power plant interests as part of the deal. But that, too, resulted in an advantage for financial buyers.

"We looked at value in terms of making sure money was in the hands of our shareholders as soon as possible," says Whitlock. GC Power structured a two-step buyout, providing the funds for Texas Genco to buy out its minority shareholders, and then immediately purchasing the unit's fossil-fueled plants for $2.2 billion. Once the NRC approves the nuclear portion of the deal, GC Power will buy the rest. "That would have been difficult for a strategic buyer to do," says Whitlock.

To be sure, running a nuclear plant is no easier for a financial buyer. But Whitlock says GC Power, while clearly a financial buyer, is actually something of "a hybrid," since its CEO is Jack A. Fusco, the former chief executive of a publicly traded power-plant holding company. In fact, Whitlock notes, each GC consortium member individually owns generation assets already, and is likely to buy more.

Indeed, "it is harder today to discern a strategic buyer from a financial buyer than it was four years ago," says Robert Daleo, CFO of The Thomson Corp., which in November sold its Thomson Media Group to Investcorp for $350 million. Despite a name that would suggest otherwise, Investcorp was viewed as strategic, and preparing to build up the business, not flip it, says Daleo. "If a financial buyer pays a strategic premium," he asks, "is it really a financial buyer?"

Says Daniel F. Akerson, Carlyle's co-chair of U.S. buyouts, "When you get a broad and deep enough portfolio, you become quasi strategic." And PE players predict their role in revitalizing moribund industries will expand significantly. Already, says Akerson, "basically the entire aftermarket automobile industry is owned by private equity."

Akerson predicts that at least four firms will raise funds of $5 billion or more this year. Given their leverage expertise, that means the top private-equity firms alone will soon wield as much as $60 billion of purchasing power.

"If consortiums are a factor, you can buy $20 billion companies and be a force for positive restructuring in the economy," the Carlyle executive says. "That's a lot of money, even in America."


Tim Reason is a senior writer at CFO.


Not for Public Consumption
The year's largest private-equity deals.*
Date Effective Target Acquirer Value of Deal
($ millions)
8/2 Cox Communications Cox Enterprises $8,390
9/13** Metro-Goldwyn-Mayer Investor Group 4,812
11/18** Mylan Laboratories Carl Icahn 4,196
10/29 Boise Cascade-Paper Asset Boise Cascade 3,700
8/27** LNR Property Riley Property Holdings 3,682
5/12 Extended Stay America Blackstone Group 3,182
7/21** Texas Genco Holdings Investor Group 2,886
8/20 PanAmSat Investor Group 2,600
5/27 UGS PLM Solutions Investor Group 2,050
7/30 Loews Cineplex Entertainment Investor Group 2,000
5/21** Verizon-Wireline Related Business The Carlyle Group 1,650
8/27 Nortek Holdings Investor Group 1,534
6/8** Refco Group Thomas H. Lee Partners 1,463
4/16 Cinemark USA Madison Dearborn Partners 1,392
7/22** AMC Entertainment Marquee Holdings 1,386
8/4 Keystone Property Trust Investor Group 1,376
11/18** Telcordia Technologies Investor Group 1,306
6/22 Iasis Healthcare Investor Group 1,306
8/20 US Oncology Welsh Carson Anderson & Stowe 1,282
8/12 Borden Chemical Apollo Management 1,200
9/2 Mervyn's Investor Group 1,200
10/29 Dresser-Rand First Reserve $1,200
*As of 12/1/04
**Date announced
Sources: Thomson Financial, company reports, CFO


Year Total Number of Deals Total Value of Deals
($ millions)
Number of LBOs Total Value of Deals
($ millions)
1994 7,706 $342,957 189 $11,077
1995 9,240 520,976 232 11,956
1996 10,450 3.1% 2.4% 2.3%
1997 11,471 911,653 220 20,440
1998 12,485 1,622,312 187 16,689
1999 11,162 1,544,456 223 31,829
2000 11,127 1,717,516 345 39,493
2001 7,699 764,813 181 11,498
2002 7,024 440,382 186 23,825
2003 7,697 558,977 169 23,569
2004* 7,304 $663,700 270 $63,500
*As of 12/1/04
Source: Thomson Financial

Monster Marriages
The 10 largest public acquisitions of 2004.*
Date Effective Target Acquirer Value of Deal
($ millions)
7/1 Bank One JPMorgan Chase $58,761
10/26 AT&T Wireless Services Cingular Wireless 47,100
11/1 SouthTrust Wachovia 14,156
11/17** Sears, Roebuck Kmart Holding 13,846
11/12 Rouse General Growth Properties 11,895
8/31 Charter One Financial Citizens Financial Group 10,530
7/15** Caesars Entertainment Harrah's Entertainment 10,224
6/4** Mandalay Resort Group MGM Mirage 7,644
10/1 National Commerce Financial SunTrust Banks 7,025
10/1 GreenPoint Financial North Fork Bancorp 6,270
*As of 12/1/04
**Date Announced
Source: Thomson Financial



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