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Private equity players, whose megadeals and megafortunes marked the height of the pre-meltdown era, have jumped back into the market in 2010. Companies such as Blackstone Group, Silver Lake Partners LP, TPG Capital, and Bain Capital Partners are revving up merger-and-acquisition transactions and IPO activity to levels not seen since pre-recessionary times. Although the size and volume of deals are still far below peak 2006-2007 numbers, experts are bracing for a possible flood of private equity-led Initial Public Offerings (IPOs) in the next year or two. "There's been a significant resurgence in private equity in 2010 — certainly over the depressed levels of late 2008 and 2009," says Douglas Warner, a partner and senior member of the private equity and hedge funds practices at Weil Gotshal & Manges LLP.
Many private shops are under the gun to exit investments they made prior to the recession. They are using IPOs and sales to deliver returns to investors — and themselves. That's partly behind the recent IPOs of Oasis Petroleum for $676.2 million by EnCap Investments LLC, and the $654.1 million IPO of Sensata Technologies by Bain Capital and Unitas Capital. Firms need to show healthy returns to convince shell-shocked investors to pour cash into new funds. Investors "don't like to commit new capital unless they're getting distributions on old committed capital," says Warner. And if they don't deliver those returns, investors could disappear. "Their lifeblood is fundraising, and if they don't have the funds around, obviously they're out of business," says Jay Marshall, managing director at AlixPartners, a corporate consulting firm.
Then there's the tax issue: There are concerns the Obama Administration may raise the rate on carried interest income when it deals with the expiration of the Bush tax breaks later this year. Private equity managers fear the federal government will start taxing carried interest income as regular income, which would hike the tax rate to near 40% from its current rate of 15%. (PE fund managers receive carried interest income as part of their compensation when assets are sold.) As a result, some private equity managers are rushing to sell investments before year end.
Merger and acquisition activity in the U.S. is up 8% so far in 2010, with dollar volume rising to $638 billion from $588.5 billion during the same period a year ago, according to Dealogic. Among the biggest deals: Blackstone's pending $4.7 billion takeout of Dynegy Inc., and the $3.4 billion acquisition of Interactive Data Corp by Silver Lake Partners and Warburg Pincus. Private-equity-led buyouts have seen a far bigger increase, with the dollar volume of buyouts surging 72% to $62.6 billion so far in 2010 from $36.4 billion a year earlier. There have been 40 PE-led IPOs so far in 2010, up three-fold from the same period a year ago, Dealogic reported. Another 39 valued at $15 billion are in the pipeline.
At the same time, many firms are sitting on a tremendous amount of "dry powder" that needs to be invested. "When you go through something like the great recession, everything stops — fundraising stops, investing stops and exits stop — and yet the clocks on their funds didn't stop," says Marshall.
Funds typically have five or six years to make investments, which means the investment window is closing on funds that were raised in the 2006-2007 era. "It's a use it or lose it thing — if you don't deploy the committed capital within that time frame, then you lose the right to invest it and therefore lose the right to earn fees on it," says Warner. There's a "heightened urgency" right now to put the money to work, adds Marshall.
Companies in the restaurant, lodging, healthcare and technology sectors have been big takeout targets this year. Apollo Management Group won a bidding war for CKE Restaurants, Golden Gate Capital acquired On the Border Mexican Grill & Cantina, Mill Road Capital recently took Rubio's Restaurants private, and TPG recently announced plans to sell its remaining shares in Burger King to 3G Capital. Some of the larger deals announced include Blackstone's pending $3.9 billion acquisition of Extended Stay Hotels, Silver Lake Partners' $3.4 billion purchase of data services firm Interactive Data, Carlyle's pending $3.7 billion acquisition of vitamin giant NBTY Inc., and GS Capital's $1.7 billion purchase of Michael Foods.
Private equity firms will likely need to use IPOs to exit larger investments, such as HCA Inc, which is owned by Bain Capital Partners, KKR and BAML Capital Partners; or Nielsen Holdings, which is owned by Thomas H. Lee Partners, Carlyle Group and Blackstone, whose IPOs are currently pending. "There's a big backlog of IPOs," says James Coulter, co-founder of TPG, a private equity firm with more than $47 billion of capital under management. Coulter expects IPO volume to surge even more if the country doesn't fall into a double-dip recession and the Christmas season is a healthy one. He likens today's environment to the 2003 to 2005 period, when the industry "grew nicely" after recovering from the tech collapse and 911 terrorist attacks. Says Greg Peterson, a partner at PricewaterhouseCoopers' transaction services group: "It's not the Armageddon situation that we saw about a year ago, where there was no ability to project month-to-month or week-to-week, let alone annually."
The volume of PE-led buyouts in the U.S. plunged to 514 deals valued at $49.2 billion in 2009 from its peak of 1,098 deals valued at $404.1 billion in 2006, according to Dealogic. The IPO window also slammed shut, with the number of PE-backed IPOs plummeting to 10 in 2008 from 81 in 2006. The economic turmoil made it next to impossible for PE firms to find and value deals. "Sellers didn't know what price to sell for, buyers didn't know what price to buy for, and the market just seized up," says Coulter
But will deal and IPO volume ever match or exceed the frothy 2006-2007 peak years? "People have short memories on Wall Street," says Warner, who predicts deal volume could be back to peak levels in five years. "We never thought we'd see another RJR Nabisco [taken private in a $30 billion deal] in 1990, and then 2006 came along and we saw TXU and HCA," whose LBOs all exceeded that. Says Mort Pierce, a partner and co-chair of the M&A practice at Dewey & LeBoeuf — "I never say never."