Stars are aligning for resurgence of buyout boom

Updated with correction

Cheap debt and easy loan terms like those available now typically set the stage for the return of the megaleveraged buyouts, but market participants are divided over what kinds of opportunities are likely to arise.

Even so, some industry insiders say big buyout firms won't be able to resist for long.

Debt is plentiful. When H.J. Heinz Co. sold $3.1 billion in B-grade bonds in March to support the $28 billion leveraged buyout of the ketchup company by Berkshire Hathaway Inc., the company got the same price it could have gotten for bonds of a much higher rating. Another ingredient necessary to finance leveraged buyouts, collateralized loan obligations, made a comeback last year, reaching a volume of $54 billion, a five-year high.

Meanwhile, private equity firms have cash to burn, with an estimated $400 billion in unspent committed capital or “dry powder.”

In the first quarter, private-equity-backed buyout deals also hit a five-year high, at a total value of $87 billion worldwide. This was a whopping 112% increase from the $41 billion in the first quarter of 2012, according to London-based alternative investment research firm Preqin.

“We have the debt conditions for the megabuyout space to pull off very large transactions again,” said Susan Long McAndrews, partner in the San Francisco office of private equity firm Pantheon Ventures, in an interview. “I shouldn't be surprised given debt conditions are so ripe — and now that (the buyouts of) Heinz and Dell have cleared the market, the level of scrutiny by investors ... comes down a little bit for the next one.” (Dell Inc. in February agreed to be taken private by a group led by Silver Lake Partners for $24.4 billion.)

Some of the largest private equity firm executives say that despite the very conducive conditions in the debt and loan markets, they have not been buying all that much. Leon Black, chairman and CEO of Apollo Global Management LLC, New York, said that over the past 15 months his firm has been a net seller and he expects that will continue.

“We've been selling everything that isn't nailed down and if nailed down, we're refinancing at great rates,” said Mr. Black, speaking at the Milken Institute Global Conference in Beverly Hills, Calif., on April 30. “Our view is that the market is pricey for doing traditional buyouts.”

Still, Mr. Black said he is not turning down deals: “When we find opportunities, it's great to have low-cost financing.”

David Bonderman, founding partner of TPG Capital, San Francisco, agreed with Mr. Black's assessment. “It's a good time to be a seller, but not a terrible time to be a buyer” because companies are not divesting subsidiaries, which has traditionally been private equity's “bread and butter,” said Mr. Bonderman, speaking on a panel with Mr. Black.

John Sokolof, managing partner of Leonard Green & Partners LP, Los Angeles, said the high prices aren't stopping his firm from buying. But he agreed with Mr. Bonderman, noting that because corporations are sitting on piles of cash they are not divesting businesses.

David Fann, president and CEO of alternative investment consulting firm TorreyCove Capital Partners LLC, said the successful sale of bonds to support the Heinz buyout shows the market is ready for multibillion-dollar buyouts again.

“If you're sitting on top of dry powder, now may be the perfect time for you to use it,” Mr. Fann said. “The conditions are almost perfect for buyouts: We are in the early innings of an economic recovery that ought to drive revenue and cash flow growth for most companies; (there is) a historically low interest rate environment; and there is great investor demand for yield so that debt is becoming more abundant.”

Executives at the largest private equity firms are on the hunt for bigger deals.

During The Blackstone Group LP's first quarter earnings call on April 18, Chairman and CEO Stephen Schwarzman noted: “We missed one or two large situations where we would have ended up putting $1 billion or more into a transaction.”

But the return of the megadeals will not be especially good news for investors, said Stephen L. Nesbitt, CEO of alternative investment consulting firm Cliffwater LLC, Marina del Rey, Calif. Many previous megadeals were flops and, because they were done by consortiums of private equity managers, left investors overexposed to a single deal.

Many of the megadeals done before the financial crisis were spectacular flops. Energy Future Holdings, the power company that was known as TXU Corp. before being taken private in 2007 in the largest megadeal to date, is reportedly on the verge of bankruptcy.

Even fixed-income investors are wary of the return of supersize buyout deals. People don't want too much exposure to a single name “in their fixed-income portfolio,” said Krishna Memani, chief investment officer of fixed income at OppenheimerFunds, New York. After the TXU buyout, most investors' fixed-income portfolios had huge concentrations of TXU debt, he said.

Still, the size of the high-yield market is driven by sellers, which are leveraged buyout target companies, and not the buyers, Mr. Memani added.

Even if the Heinz and Dell LBOs do not close, the high-yield markets are awash in capital from hedge funds, mutual funds and some pension plans. This opens the door for LBO deals between $10 billion and $15 billion, said a debt manager who declined to be identified.

The “sweet spot” for leveraged buyouts right now is between $5 billion and $10 billion, Mr. Memani said. “Last cycle (pre-crisis), people were pitching business saying they were doing $20 billion transactions. It was an overstatement at that point and an overstatement at this point,” Mr. Memani said.

Heinz is an exception because Berkshire Hathaway is providing mezzanine capital, he said, noting without that assist, the deal “would not have gotten financed.”

So, should the buyouts of Heinz and Dell close, the definition of megabuyout will expand, Mr. Fann said. The government's quantitative easing measures that have kept interest rates low has benefited private equity firms in a big way, easing their way into very large deals, he said.

“Our view is that buyout firms are big beneficiaries of quantitative easing — whether it's been refinancing capital structures, dividend recapitalizations or the financing of new transactions,” he said.

“With that said, we worry about any blips to the economic recovery — purchase multiples increasing and geopolitical disasters — that could cause all of this to come crashing down,” Mr. Fann said. n