Mega Private Equity Deal in 2010: Some Fundamentals in Place

Static Chaos's picture

By Static Chaos

With Merger and Acquisition really picking up steam in the last month, the question arises whether private equity will be able to complete a major move in the remainder of 2010. This past week Intel acquired software security firm McAfee for $7.7 billion in an all cash deal and the prior week BHP offered $40 Billion to take over Potash Corp. from shareholders.

In contrast, the latest deal involving private equity--Blackstone acquiring Dynergy for $543 million--is a far cry from the heyday of private equity deals back in 2006, when deals such as Harrah`s Entertainment, Hospital Corp. of America, Clear Channel Communications, Kinder Morgan, and Freescale Semiconductor each worth more than $17 Billion dollars took place. In 2007, Blackstone acquiring Equity Office Properties Trust for $38.9 billion, and TXU went for a $42 Billion three way deal with Goldman Sachs, Kohlberg Kravis Roberts, and TPG.

So, all this M&A activity begs the question--where the heck is private equity? Can they still compete with large companies sitting on a pile of cash?

I understand the financing travails and the freezing up of the credit markets in 2008, but this is late 2010 and supposedly private equity has all this money from investors that they have been unable to utilize for deals over the last three years. In short, what could private equity be waiting for?

There are some great bargains out there in undervalued companies that have huge cash flows, little debt, large cash stockpiles, and there is a low cost of capital right now for financing deals. Do you need an engraved invitation to the ever-present M&A party? If you cannot complete a major deal now, then when will you be able to do a major deal?

The cost of capital is only going to go up in the future, in a major way. Frankly, it seems that the private equity community is like the proverbial deer in headlights, and still stuck in the malaise, fear, and uncertainty of the past three years that they are slow to react to the changing landscape of deal making. And this is their core business deal making.

It is apparent that the dynamics have changed in the private equity buyout game, and maybe the firms are waiting for the good old days. But the good old days are long gone, and you have capital to deploy, so you’d better either start adapting to the new environment or start giving your capital back to investors so they can realize a better return on their money.

There is the stigma of all those bad private equity sham deals that have occurred over the last decade that probably makes many banks weary of private equity when they inquire about financing deals. So, yes the days of the sham deals are over where you buyout some garbage company that has a declining business model, uncompetitive business, but little debt, and you take it private, lever up the balance sheet with monstrous debt obligations, pay yourself a huge dividend recapping your original investment, and then taking it back public in a better market with higher multiples. The reason this type of deal is dead is because there will always be a bag holder, and banks have ultimately been caught in the crossfire too many times as the one picking up the pieces in the end.

Most likely, all future private equity deals will involve more of the firm`s own money in the deal. But private equity, by most accounts, has been sitting on large amounts of capital, so the money is there for deals. Furthermore, there are plenty of legitimate value enhancing, highly attractive deals out there, which this cash may be applied to right now, as there are great fundamentals (outlined below) in the marketplace for the private equity model.

  • The valuations of many public companies are well below the average of the last 10 years.  
  • There are many solid companies that have little debt on their books. 
  • Many companies with strong cash flows. 
  • The cost of capital is extremely attractive at these rates of financing, providing banks believe that private equity firms have some skin in the game and willing to share the risk. But this should have always been the model, as shared risk inevitably leads to high quality deals and not the sham deals where risks are absorbed by others. 
  • The M&A cycle for the next 10 years is just starting, so the best deals are still available.  
  • The next cycle will be highly inflationary, which means you are taking assets out of the market at the bottom of a deflationary cycle, and bringing these same assets back to the public markets in three years in the midst of an inflationary cycle where the value of the same assets receives a much higher multiple due to the inflation of asset prices.  
  • Banks have recapitalized for the past three years, and they now need to start applying more of their capital base to lending projects with higher returns, they just need the demand component to pick up, and this is where private equity firms come into fill this void.

So, how likely is it that we have a$100 Billion private equity deal in the remainder of this year? Well, at the beginning of this year it would have seemed impossible, but the dynamics are there for a deal to occur. Things really just have to fall into place. With the latest rumblings of M&A activity, there is an increasing chance that we witness a Mega Private Equity deal that really shakes up the current valuation models regarding what public companies are worth.

A case in point is a company like HP with a trailing P/E around 11, has solid growth, leader in numerous business segments within technology, sits on a large amount of cash, and is grossly mispriced in the market place compared to a firm like Dell with a trailing P/E around 16.


HP has many of the components necessary for a private equity mega deal, solid company with a bright future, extremely low multiple, assets are worth more than the current market cap if sold separately, low relative debt, strong cash flows, large cash reserves, relevant industry due to demands from corportations to increase productivity, lacks a CEO, leverageable, and most of all--very financeable for a major deal to banks.

This is one of my candidates for a Mega Private Equity deal. What are some of the companies that you think will make for great Mega Private Equity Deals for the remainder of 2010?

Static Chaos

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Reese Bobby's picture

Private Equity is a joke.  All about nice suits, fancy offices, confident marketing and deep moral corruption.  No brains required.

But they need abundant and cheap financing.  It is all about leverage. They are not very sensitive about the purchase valuation. Their business model assumes a low success rate, so the minority of deals that work out need to be BIG winners.  The model doesn't work with the 40+% equity contributions the market is currently requiring.

The PE scam works with cheap financing with weak covenants that lever a 20% equity contribution. With that in hand they can buy a productive company, shield income from taxes with the heavy debt load, fire lots of workers, sell some assets and under-spend on the business.  In short, wring cash out and generally pillage the poor enterprise.  This won't work forever so they need to get out in 3-5 years.  Anybody with a grade school education and a lack of moral compass can execute this model.

By the way, the Dynegy buyout was a special kind of scam.  The buyer got a public company to sell their good assets before the buyout so the prize came with lots of cash to steal.  The covenants in the DYN bonds have no restricted payment protections so all this cash can be sent up to the PE firm in short order.  The buyout will be more than paid for and the PE firm still owns a free long-shot option on the rest of the company.  As for the Dynegy workers, well there is no good news for you.  The PE firm has pillaged your company to finance all their mansions and private planes...

MichaelG's picture

"shield income from taxes with the heavy debt load, fire lots of workers, sell some assets and under-spend on the business. In short, wring cash out and generally pillage the poor enterprise"  

Absolutely.  Plus, aren't most companies currently doing this anyway, to themselves, with no help from the masters of the PE universe?  (e.g. All those 'impressive' earnings based on little more* than SG&A reductions.)  The buy-lever-shred market must be getting a little crowded.

* Oh, and mark-to-end of double rainbow loan-loss reserve reductions.  And comparisons with one of the worst Q2s in history.  It's not really surprising that the "valuations of many public companies are well below the average of the last 10 years," at the end of the world.  Did I say 'world'?  I meant 'day'.

caconhma's picture

Mega Private Equity deals are not good either for business or economy. The purpose of these Mega Private Equity deals is to repackage existing companies and layoff its employees.

Managers of these Mega Private Equities have no business expertise or even a desire to make things work. Their exclusive desire is to make a quick buck by destroying companies they acquire and nothing else.

sgt_doom's picture

Some excellent and poignant comments on that Blackstone/Dynegy deal:

Now, there have been some intelligent legal changes regarding the raping and pillaging of Blackstone et al. over in European Union, Germany and Denmark come immediately to mind.

Which would crimp their style.  Also, they have all those PIK notes (payment-in-kind, but considerably higher basis points) coming due, and those rather flaky CLOs, intertwined with naked swaps -- still heavily promoted by our Goldman Sachs-owned Treasury Department, but the Euros have been highly critical of lately.

Besides, old Peter G. Peterson is busy, with his other PE leveraged buyout cronies, with trying to steal that healthy Social Security $2.7 billion fund -- from those of us who actually pay our taxes, unlike Peterson and his gang.

MichaelG's picture

Aren't HP pretty big on leasing? I'm just wondering if they'd be much affected by the accounting rules changes Bruce Krasting mentioned the other day.

sgt_doom's picture

A most intelligent point.

And I would reason that HP is unlikely to be next PE deal.

Instead, per that later web site post I mentioned, it is highly likely there will be more, many more, energy deals in the ofting.


Monkey Craig's picture

I'm not a CPA, but I understand that the new rules will hurt retailers which lease their facilities (think SBUX). The retailers will have to bring their liabilities on balance sheet and this will increase debt levels. Obviously, the sophisticated bond buyers and lenders have been reading the operating leases (disclosed in the Notes of the Audit) for years.

TGT, by the way, owns the bulk of their store locations.

Itsalie's picture

PE are playing musical chairs in Europe and Asia - those raising new funds are busily selling their portfolio to those trying to spend some of the $500b of dry powder to fend off limited partners seeking a reduction in the fat 2% fee. Its window dressing a la PE. But don't shed tears for the investors/limited partners, they are nothing like the long suffering retail investors pulling out record sums from mutual funds. The LPs are exclusively the Harvards, Princeton, Yale (Swensen hah!), Calpers and xICs - they manage money belonging to faceless organization and fly around attending LP meetings all year round. They won't be jeopardising their relationship with the PE funds - that would be like firing themselves from their jobs; besides I know of no LP who do not enjoy the LP meetings aka pilgrimage to Hawaii or Half Moon Bay to paly golf, or Shanghai/Macau to be "entertained".

Market Analyst's picture

Another potential candidate would be GS with a p/e around 8, and a current market cap around  $77 Billion, and too high profile as a public company, need to get out of the spotlight. Shareholders might want more of a dividend going forward instead of those excessive bonuses.

Dismal Scientist's picture

Time to take GS private then. Am waiting for the first MBO's to come in this cycle. Not to mention a continuation of the M&A we are seeing, which is just as well for those pesky investment banker types....



Mitchman's picture

PE has a 5 to 7 year time horizon on their investments and the outlook is way too uncertain to take the risk that they will be able to get out at a profit in that time frame.

Bartanist's picture

My experience with private equity is that the entire model is based on borrowing money from banks at libor +1.25% paying the acquisition price and then financing the target company in a couple of tranches at 7% to 9% then the secondary tranche at 14% to 17%. The target companies are cash strapped and have to free cash through consolidation and firing all expensive people then hiring cheap people, but the PE company has plenty of cash flow as the target company shrinks its balance sheet and expenses.

The only hitch with the PE companies is that they then want to sell the target companies before the shit hits the fan due to a complete lack of investment during the PE company's ownership.

My guess is that the banks and others have caught onto the scam.

Monkey Craig's picture

PE is also reliant on few, if any, covenants and credit officers may push for these in the future if leverage levels increase or acquisitions get sillier....a vibrant PE market was a bubble activity, think 2005 or 2006

snowball777's picture

Private equity is circling, waiting.

Fred Hayek's picture

Wouldn't we expect to see some actual M&A action just when companies think things are about to switch over from deflation to inflations?

williambanzai7's picture

Sham deal is synonymous with private equity, at least in the M&A sense.