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.
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?
Disclosure: No Positions