A High-water Mark?

Private-equity firms boosted deal values again in 2005, but resurgent corporate buyers and higher borrowing costs may rein them in this year.
Tim ReasonJanuary 5, 2006

It was the year of the megadeal. Eleven North American companies were snatched up during 2005 for prices that topped $10 billion per deal, including such household names as Gillette, MBNA, Unocal, Adelphia, AT&T, Hertz, and Georgia-Pacific. As CFO went to press, these acquisitions had helped push aggregate deal value for the year to $839 billion. That tops 2004’s total of $692 billion and makes 2005 the hottest year for deals in five years. And 2006 is widely expected to be hotter, says Robert Friedman, senior managing director of Blackstone Group. In addition to continued strong involvement by private-equity firms such as his, he predicts “corporate buyers may be considerably more active in 2006 than they have been during the previous four years.”

Not since 2000, when peak stock prices sparked an intense burst of mergers and acquisitions, has the market been so hot. Much of the fuel last year came from private-equity players, who poured money into all levels of the market, continuing a trend that took off in 2004. By pooling funds in club deals and leveraging still-cheap debt, private-equity funds took part in some of the year’s largest deals, including acquisitions whose size once would have excluded all but corporate buyers. And private-equity firms still have huge funds yet to be invested. “It’s just unbelievable how massive the capital imbalance is,” says Paul Deninger, vice chairman of New York–based investment bank Jefferies & Co.

Of the top 100 deals with a value of more than $1 billion, 18 involved private-equity buyers. The largest was the acquisition of Hertz, the car-rental company, by Clayton, Dubilier & Rice, The Carlyle Group, and Merrill Lynch Global Private Equity. At $15 billion, Hertz was the sixth-largest deal of the year. Other notable private-equity purchases included SunGard, Toys “R” Us, Mylan Laboratories, and Neiman-Marcus.

A Good Run

But the unfettered purchasing power of private-equity firms also may have reached its high-water mark in 2005. Private-equity buyers had filled the void created in the aftermath of the dot-com collapse and the accounting scandals. Despite burgeoning stockpiles of cash, companies grew skittish about acquisitions and began to divest noncore businesses. That created opportunities for private-equity firms, whose buying power was boosted by low interest rates and willing lenders. “The unlevel playing field tilted in favor of the leveraged financial buyer,” says Friedman.

Now, it may be tilting back. Rising interest rates could put a crimp in the lending that has been such a boon to private-equity buyers. Furthermore, after two years of dormancy, corporate buyers returned to the market in 2004. Their activity continued to increase in 2005, though they remain selective about purchases. And while private-equity buyouts rose from just 2 percent of U.S. M&A in 2000 to 15 percent as of December 2005 (see “Deals Bounce Back” at the end of this article), experts predict those percentages may now be leveling off. “The trend may have hit its peak,” observes Friedman. Indeed, as of December, private-equity firms had done 123 fewer deals last year than in all of 2004, though megadeals boosted overall deal value 52 percent, to $123 billion.

Private-equity funds have put an indelible stamp on U.S. M&A. Particularly among deals valued at from $30 million to $250 million, spending sprees have given many private-equity firms deep, industry-focused portfolios. Many now purchase companies not solely as investments, but to complement companies in their existing portfolios. “Financial buyers have become more strategic because they own or have invested in platform companies,” says Roger Aguinaldo, CEO and publisher of The M&A Advisor.

Strategic vs. Financial

Consider the $173 million buyout of publicly held Brooktrout, a network-hardware maker in Needham, Massachusetts, by hardware maker Excel Switching Corp. Excel’s parent, EAS Group, is owned by private-equity firms including Oak Investment Partners, George Soros’s TowerBrook Investors, and Anshutz Investment. “That’s a financial buyer acting like a strategic buyer,” says Jefferies’s Deninger. “The distinction is blurring.”

Further blurring the line is the tendency of financial and corporate buyers to team up on purchases, a trend that may accelerate. Blackstone’s Friedman says that since 1988, half of his firm’s total investing has involved corporate partners. Such partnerships benefit Blackstone, he says, because corporate buyers tend to have a strategic motive to buy, and his firm benefits from management insight into the business. In 2004, for example, Blackstone struck a partnership with American Metals & Coal International and First Reserve Corp. to buy Foundation Coal for $995 million.

In the past, private-equity firms often took the controlling position in such deals. That helped companies keep the acquisition debt off-balance-sheet. Under Fin 46R, such deals are harder today, particularly if there is a prenegotiated exit strategy. “It is very important that care be taken to structure around the complex rules of what is required to be consolidated for financial-reporting purposes,” warns John R. O’Neill, leader of Ernst & Young’s private-equity practice.

A more common reason for corporations and private-equity firms to partner is to snag different pieces of an acquired company. One such example is Nasdaq, which teamed up with Silver Lake Partners, a private-equity firm in Menlo Park, California, to buy Instinet Group, an institutional broker, for $1.9 billion in 2005. Nasdaq wants only one component: INET, an electronic marketplace. When the transaction is completed, the partners will split the business in two, Nasdaq taking INET and Silver Lake taking Instinet.

Tim Reason is a senior editor at CFO.

Top 20 North American Acquisitions*
Announced Target Buyer In $ Billions
December 28 Gillette Procter & Gamble 57.9
June 30 MBNA Bank of America 34.4
April 4 Unocal ChevronTexaco 17.7
February 1 Adelphia Communications Time Warner/Comcast 17.7
January 31 AT&T SBC Communications 15.0
September 12 Hertz (Ford Motor) The Carlyle Group/Clayton, Dubilier & Rice 15.0
November 13 Georgia-Pacific Koch Industries 12.5
January 31 Travelers Life & Annuity (Citigroup) MetLife 11.8
February 28 The May Department Stores Federated Department Stores 11.6
October 11 Falconbridge Inco 10.6
March 28 SunGard Data Systems Private-equity group 10.3
October 31 Placer Dome Barrick Gold 8.9
May 9 Cinergy Duke Energy 8.8
April 25 Premcor Valero Energy 7.9
October 10 Jefferson-Pilot Lincoln National Life Insurance 7.5
February 14 MCI Verizon Communications 7.2
July 6 PacifiCare Health Systems UnitedHealth Group 7.0
July 25 IVAX Teva Pharmaceutical Industries 6.9
November 18 GE Insurance Solutions/Employers Reinsurance (General Electric) Schweizerische Rückversicherung 6.8
November 18 Scientific-Atlanta Cisco Systems 6.6
*As of November 30, 2005
Source: FactSet Mergerstat LLC

Deals Bounce Back
M&A has its best year since 2000…

Year Deal Value ($ Billions) Number of Deals
1999 1,283 9,027
2000 1,266 12,169
2001 571 9,018
2002 375 8,144
2003 443 8,257
2004 692 9,726
2005* 839 9,181

…thanks in part to private-equity buyouts, shown here as a percentage of total U.S. M&A.


*As of November 30
Source: FactSet Mergerstat LLC