Or: Don’t Touch That Dial
I do hope everybody else is right and I’m wrong as the last “double-dipper” standing, who still believes another economic decline looms. I hope I’m wrong in still believing there’s no more “road to kick the can down” for our states and cities and for toxic debt that banks have not written off and for commercial real estate that’s under water, sucking air through an oxygen tube. And, I hope I’m wrong about believing the housing mess will continue to worsen. And, finally, I hope I’m wrong about consumer demand barely budging back, and worse, actually dropping for everything other than absolute essentials such as food, gas, health care, etc.
For all the obvious reasons, I hope I am wrong. If I am not, Meredith Whitney’s predictions of 50-100 municipalities defaulting could come true, and public sector layoffs would be enormous. Banks would offset their pressures (including those beset by the government) by seizing up on lending. Commercial real estate would tank, and foreclosures might continue ‘down the road’ indefinitely. Unemployment would spike back up, putting downward pressure on consumer demand and dropping the economy into deflation territory. No amount of further quantitative easing by the Fed would help, and the $2 trillion that corporate America is sitting on would certainly not be used to rehire workers or invest in growth.
So, if I’m right and everybody else is wrong, the private equity and M&A guys may not want to be “dialing for dollars” in pursuit of deals.
If I’m Wrong
On the other hand, if the tooth fairy really does exist, then we’re in for a period of renewed deal-making. A lot of ‘dry powder,’ or roughly $400 billion of investment capital, is anxiously being readied for deal making in the world of private equity, according to Preqin, a market research firm. About half of that will be targeting U.S. opportunities.
Many of the funds raised in 2006 and 2007 are now burning holes in their managers’ pockets, having remained relatively inactive during the recession. There’s a pent up sense of urgency among investors to put that capital to work.
And, as for that $2 trillion war chest across corporate America, even if consumer demand and growth continue their slog back, and part of that capital is invested in hiring and expansion, there will still be considerable funds for M&A deals. And, in a share shrinking economy, consolidation is a priority growth strategy for healthy companies, and a positive exit strategy for the weak.
The Good News
Again, if I’m wrong, the playing field for deals is kind of perfect from a timing and opportunity perspective. We’re still early enough in the recovery stage that the valuations of many public companies, even those with minimal debt and healthy cash flows, are below the last decade’s average. Also, retail real estate values can be attractive either from a sale (revenue generation) or closing (cost reduction)perspective. Furthermore, for those interested in strategic acquisitions or for longer term growth objectives, international expansion opportunities abound.
Also, since banks have been building back capital during the recession, the cost of financing is attractive, particularly for deals promising higher levels of return. Finally, if inflation kicks up over the next few years, those deals made today at the assets’ deflated value can reemerge with a much higher multiple in a more inflationary period down the road.
According to Dealogic, the “dealers” are already off and running with 53 buyouts so far this year, totaling about $9 billion, up from just over a billion this time last year.
The not-so-good news, in one respect, is that the “wild west” of deal making and mind-blowing leveraging that occurred pre-bubble bursting, is over (at least until it isn’t). While the cost of capital may be attractive, it will be managed very judiciously and with more caution. Essentially, the public and private pools of capital are no longer going to throw “free” money to a bunch of “deal cowboys” who used to acquire and take private uncompetitive companies that should have been shot dead. Many would leverage enormous new debt (with little of their own skin in the game) onto the balance sheet, recapping the original investment, taking a big dividend, and eventually taking it public again into a rising market at higher multiples. But, since the business was a dud when acquired and likely no better in its public reemergence, the funds who lent so freely would often be left with the mess. So, good-bye cowboys, hello buttoned-up thinkers.
The biggest private equity firms are raising far less than they were during the bubble days. Fortune magazine’s columnist Dan Primack estimated in his Term Sheet blog that the ‘Big Seven,’ which include KKR and Blackstone, among others, could come up with about $41 billion, or half the pre-crash level, indicating cautionary and more limited activity for mega-deals, at least through 2011.
It’s all About ‘Ops’
So, the days of ‘financial engineering to buy low, move deck chairs and sell high’ are, for the time being, over. The smart money is with those who are seriously intent on, and capable of, either fixing or strategically repositioning, or creating new value for growth, for companies they seek to acquire. One of the biggest ‘operators’ as they are called, is TPG Capital, who acquired J.Crew in 1997, installed Millard “Mickey” Drexler as its CEO, repositioned the business for growth, successfully took it public in 2006, and just recently acquired it again. Once more, with Drexler at the helm and his vision regarding where new growth can be found, along with the assistance of TPG’s considerable pool of highly experienced ‘operators,’ the speculation is that this combination can much more successfully be accomplished as a privately held business.
The Competition: Corporate America
As revenues tanked for corporate America during the recession, they cost-cut their way to increased productivity and profitability, and are now sitting on about $2 trillion in cash. So, while some of it may be used to buy into the slow recovery by rehiring and expanding organically, most of it will pursue growth through acquisitions.
And, those now ‘leaner and meaner’ companies, having made it through the recession, are in several ways better positioned to win in the ‘deal’ market. First of all, their cash is free, while private equity debt will come at a price, thus giving the corporate players greater bidding power. Also, the ‘strategics’ as they’re called, are just that. They are better positioned to both identify and assess the best ‘deal’ fits for their strategic growth objectives, and in most cases, will have already defined where cost-saving and growth synergies exist. Thus, they can rationalize a higher premium for the acquisition. Lastly, therefore, the biggest of the corporate players will have access to greater funding for the larger deals, if necessary, than even the biggest of private equity firms. So, while the private equity business will certainly accelerate, their share of the total deals may be less than realized during the pre-recession period.
My final comment: if you do believe in the tooth fairy and a lasting economic rebound, then by all means, let the deals begin.