Mayday or Payday?

By Eleanor Haas

Just how far-reaching is the fallout from July’s credit crash? Major financial markets firms took big hits, and two lost their CEOs – Merrill and Citi.  Morgan Stanley just lost a co-president. News commentators wonder aloud whether we’re headed for a recession. In fact, news media are full of gloom and doom. But perhaps their heads are too high up in theoretical clouds to see the reality that the sky has not fallen - smart investors are still making money.

My friend John says his HNI friends (High Net Worth Individuals) are fleeing to the security of mutual funds. My friend Jeff is having success raising a new venture fund.  My friend Arthur is judiciously managing his portfolio of real estate investments, buying or selling, wherever the best advantage lies.  Three different kinds of opportunity for three different kinds of savvy investors.

In other words, financial life goes on. maybe It’s not mayday after all – at least not yet.

Speakers from three private equity funds bore this out last evening in the course of a panel discussion on Exit Strategies and Fundraising in a Changing Environment, which was sponsored by WAVE (Women’s Association of Venture and Private Equity). Opportunities abound for those who know what they’re doing.

Timing is everything, said Raquel Palmer, a partner with KPS Capital partners, which buys troubled companies and fixes them. “We had nine exits in fourteen months,” she said, “the foreign market is still open. The US is on sale. European and Japanese strategists get good value.”

“The market is open, but selectively, by company and by sponsor” said Linda LaGorga, Managing Director, Financial Sponsors Group, Goldman Sachs, who sees good exits for strong assets in the $50 million EBITDA and above market. “The financing market is volatile. It’s there for some assets, not others. You have to get ready and time it.”

“Strategics were not hurt by the bank pull-back on financing, as private equity funds were,” said Bill Jarrett, Managing Director, Lower Middle Market, Goldsmith Agio Helms/Lazard Middle Market. “We’re more selective. Some industries are out of favor – housing. Service industries are dong well, for companies with good cash flow and EBITDA.”

Services with good cash flow and steady growth, which are not cyclical, sell well in this market, and buyers are out there, agreed Ms. Gorga. Large private equity funds want to buy by the end of 2008, so they play at the lower level, $750 million, look at smaller assets in order to put money to work. PIPES are another way to put equity to work now and be in a good position later.

Niche companies in their segments - often with consolidation - are a good bet. Mr. Jarrett sees “lots of buyers for rollups and synergistic acquisitions. An international component to the transaction can be a deal sweetener – a foreign buyer or an international component of the company.

What private equity buyers have to look at in making an investment is the exit opportunities, so they look for companies with strong market share – a good niche player with a franchise, Ms. Palmer pointed out.

What about valuation, pricing and terms?

• There’s still a backlog of leveraged loans, and this      impacts big buyouts, as does concern about a potential recession and the      volatility of the housing market. Most deals in the $50 million and above market have covenants,      going back to the more traditional deal. Leverage has come down. It’s      2002 all over again. The market      will recover.
• Valuations are down. There’s a shifting of risk – escrows, warrants, liabilities. Sellers may take lower multiples if the      terms remove certain escrow commitments. Seller financing is coming back, which can help bridge the gap      between expectations and valuations.
• The lower middle market depends on smaller banks for      financing. The pullback is at the      high end of the market, not this one, where lending may now be a 3 times      EBITDA as opposed to 3.5 times. Smaller banks are cautious now, but they’re still financing      transactions.

What kinds of deals have you had since the credit crisis began?

• KPS is having “great deal flow” because companies      can’t readily get bailout funds. Two of four companies KPS is looking at are operating in Chapter      11. This makes them easy to clean      up and recapitalize. KPS expects to      see more of this. Investment banks      used to dictate pricing with staple financing, but people are not seeing      these any more.
• The Middle East has huge amounts of money -  multiples of the largest US funds - and offers good ways to sell a company. New lenders are stepping up – new banks are entering the market. Mezzanine funds are key. Goldman has a $9 billion fund that is stepping in and taking a subordinated part of the capital structure.
• Typical deals take six months but now often take longer. On the other hand, a strategic - a domestic strategic – just did a deal at 10 times revenue in two months – with no book. International buyers take longer.

What about buy side opportunities?

• There’s still a lot of liquidity in the market. People will have to put in more equity,      and sellers have to have more reasonable expectations. Private equity funds raise funds to buy      debt and then take on debt to do this. That’s high risk. Many      private equity funds won’t be successful raising funds because they can’t differentiate or create value for investors. Smaller PEs will vanish.
• It’s a good time to buy a business and to buy it      cheaper, and lots of companies in distress is an incentive to buy. Hedge funds are tempted. Their managers know how to run funds but      lack experience with Chapter 11 and restructuring. They’re getting smart about Chapter 11      strategies with distressed companies.
• Seller expectations will come down, i.e., valuations. The credit market will stabilize. 2002 buyers did very well. You just can’t predict the timing of the cycle.
• PEs continue raising a lot of money. This adds to the buy side. Boomers are aging, are concerned about possible increases in the capital gains tax and so want to sell now. Corporate performance is strong. The stock market is off but companies still make acquisitions. Smaller banks will continue to lend.

To quote the French, the more things change, the more they are the same. Those who remember 2002 and other periods like this have the confidence to make wise decisions. Those who know what they’re doing do it right. For them, it’s payday. For the unknowing or under experienced, beware. For them, it could well be mayday.

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Comments

[monica kermani]

Interesting article. I know this is old, but unfortunately it's not like the economy has really changed and gotten better since this was written... Anyway, I'm looking to buy a business instead of starting one from scratch because I think it'll be easier. Only hard part right now is that I haven't been able to find something that I like. Do you have any suggestions? thanks.

[Claire Nortel]

@Monica, Have you looked into small business groups in your area? They should be able to help you and direct you to the right people.

Also, check out [link="http://www.biztrader.com"]BizTrader.com[/link], which is an online global marketplace where you can invest in, buy, and sell a business. There's a wide selection to choose from, so you should be able to find what you're looking for. You can also find a lender or find a broker, if you need either. Check it out and good luck!