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Trends in Middle Market Private Equity


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Trends in Middle Market Private Equity White Paper

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Trends in Middle Market Private Equity

  1. 1. Top trends in middle-market private equity
  2. 2. About the author Contents Harris Smith 1 Executive summary Managing Partner, Private Equity and Strategic Relationships 3 The impact of the credit crunch Harris Smith is a Certified Public Accountant and the managing partner of Private Equity and Strategic Relationships for 7 The explosion of cross-border M&A activity Grant Thornton LLP. In 1976 Smith started his career in the Baltimore office of Grant Thornton. In 1986, he was promoted to 11 The proliferation of operational partners partner and in 1989 he relocated to the Southern California office to head up the Assurance practice. In 1998, Smith was promoted 13 The emergence of sovereign wealth funds to office managing partner of the Greater Bay Area offices, and in 2003 he became the West Region managing partner. In 2008 he 16 The middle-market compensation squeeze became the managing partner of Private Equity and Strategic Relationships. 18 Three hot sectors for investment In his current role, Smith is responsible for the development and 21 The natural evolution of the private equity firm enhancement of strategic relationships for the firm and at the same time, overseeing the services provided to private equity 23 Conclusion clients. This dual role provides Smith the opportunity to further elevate the firm’s reputation and to create relationships with key influencers to deal with challenges in the marketplace and to enhance our brand. With over 30 years of experience, Smith is a member of the firm’s National Leadership Team and the sponsor of Grant Thornton’s Women’s Initiative. Smith is a director, executive committee member and chairman of the Association of Corporate Growth. He served as president (2003) and director of the San Francisco Chapter of the Association of Corporate Growth beginning in 2000. Smith resides in Los Angeles with Jill, his wife of 26 years, and is the father of twins, Stephanie and Jordan, who are seniors at the University of Southern California and UC Berkeley, respectively. Acknowledgements The author would like to thank Danielle Fugazy, Lora DeSanto, Pat Fanelli and Bill Haynes for their contributions to this project.
  3. 3. Executive summary This white paper explores seven trends The middle market has been able to hold its own quite well that have recently altered the way the compared to the big-deal market. private equity community conducts business. Some of the issues explored in the white paper are important because of The key areas explored are: The first trend is that a cyclical the cyclicality of the private equity • the impact of the credit crunch, market brings change and change business, while others are emerging • the explosion of cross-border M&A breeds uncertainty. The subprime trends that may become mainstream in activity, mortgage/housing debacle and its impact the coming years. As these private equity • the proliferation of operational on credit is the primary trend that has trends have gained visibility and affected partners, triggered the 2008 down cycle. Private investment opportunity in the middle- • the emergence of sovereign wealth equity firms are returning to the days market private equity sector, funds, where they spend substantially more time Grant Thornton decided to seek a broad • the middle-market compensation looking for quality companies to invest in, perspective on their current and emerging squeeze, and they are performing more thorough impact, how they developed, what is • three hot sectors for investment, and due diligence rather than jumping in to an driving them, how widespread they have • the natural evolution of the private investment headfirst. become, how they affect market equity firm. However, contrary to the headlines participants and what challenges they that grace industry trade publications, all create for the middle market. is not doom and gloom. The middle The current environment To explore these questions, a The private equity market will finish out a market has been able to hold its own quite Grant Thornton team considered many year that will be remembered as the one well compared to the big-deal market. data points, including reviewing when the record dealmaking streak ended. That being said, there’s no denying that Association for Corporate Growth A new era of quiet uncertainty has come there has been a flight to quality, a (ACG) and Thomson Reuters surveys, over the industry. Gone are the days of contraction in leverage multiples and a interviewing private equity professionals frenzied dealmaking. 2007 produced the tightening of financing terms. The good about the state of the market, and drawing third and last year of consecutive record- news is that deals are still getting done. upon the expertise and experiences of our breaking deal volume. According to The second trend is that private equity private equity service professionals. Thomson Reuters, U.S. buyout firms firms have adapted to the changing Through many different sources and completed only about $55 billion worth market by opting to do cross-border original reporting, Grant Thornton of deals during the first half of 2008, deals. Middle-market investment banking compiled the white paper to give readers a making it extremely doubtful that 2008 firms, like Harris Williams & Co. for better understanding of where the middle will reach the $475 billion in deals example, say that they expect to spend market is today, how it got there and completed in 2007. more time on globalization and emerging where it is heading. markets, and they see their clients also doing so in the next year. Top trends in middle-market private equity 1
  4. 4. With the lines blurring between private equity firms, hedge funds, lenders and bankers, private equity firms are emerging as asset managers. A third trend is the hiring of The fourth trend affecting the private Lastly, with the lines blurring operational partners, representing equity community is the emergence of between private equity firms, hedge another way private equity firms have sovereign wealth funds (SWFs). Morgan funds, lenders and bankers, private equity been able to transform themselves. Hiring Stanley researchers say SWFs, mainly in firms are emerging as asset managers. operational partners is a recent Asia and the Middle East, poured around This trend has already begun to take phenomenon. While larger firms always $45 billion into a range of companies and place in the larger market, and is now put big-name advisors on their letterhead, assets in 2007 alone. Some analysts believe emerging in the middle market. Many middle-market firms have increasingly SWF assets could reach $15 trillion by believe it is the natural evolution of the been hiring partners who don’t 2015. SWFs are here to stay; they will industry. This white paper explores what necessarily have private equity have an increasing long-term impact on firms are doing to drive this trend, and knowledge, but who do possess expert the marketplace. what some middle-market private equity knowledge in a particular sector. Touting The squeeze on middle-market managers think of it. operational partners is a good way for compensation is the fifth significant trend. firms to woo management teams in As the megafunds have grown even larger, today’s market, where competition for they have hired more talent to broaden quality deals is more fierce than ever. their scope, luring private equity talent Bringing extra capabilities to the away from middle-market firms. This bargaining table can only help firms white paper discusses practices that become more competitive. middle-market firms are using to retain top talent. The sixth trend is that certain industry sectors have remained particularly strong, despite the global credit crisis. The technology, health care and energy sectors continue to present strong investment opportunities and are expected to do so for years to come. 2 Top trends in middle-market private equity
  5. 5. The impact of the credit crunch In August 2007, the credit markets began Figure 1.1 their contraction, leaving the private All North American M&A activity* equity market in a very different place For the years ended Dec. 31, 2001-07, and the period Jan. 1-May 6, 2008, annualized than it had been for the previous five years. Gone are the days of frenzied Deal value in billions Number of transactions dealmaking; back are the days of caution 1,892 and careful due diligence. 1,799 For the next year or so, fewer deals in general are expected to be completed. As 1,371 Figure 1.1 demonstrates, M&A activity 978 967 899 remains down, regardless of deal size. 587 However, M&A activity for deals larger 478 than $500 million has slowed considerably more than smaller deals (see Figures 1.2 2001 2002 2003 2004 2005 2006 2007 2008 and 1.3). In addition, there has been a Annualized Source: Harris Williams & Co. compiled from third-party sources decrease in capital put into new private equity deals. *Excludes minority stake purchases, acquisitions of remaining interest, self-tenders and repurchases Figure 1.3 Figure 1.2 M&A large-cap transaction activity M&A middle-market transaction activity For the months ended Jan. 1, 2007-April 30, 2008 For the months ended Jan. 1, 2007-April 30, 2008 Deal value in billions Number of transactions Deal value in billions Number of transactions 75.0 $30 $300 150 62.5 $25 $250 125 50.0 $20 $200 100 37.5 $15 $150 75 25.0 $10 $100 50 12.5 $5 $50 25 0.0 $0 $0 0 11 7 7 7 11 7 7 7 07 07 07 07 07 07 07 07 07 /0 /0 /0 08 08 08 08 07 07 07 07 07 07 07 07 07 /0 /0 /0 08 08 08 08 10 12 1/ 2/ 3/ 4/ 5/ 6/ 7/ 8/ 9/ 1/ 2/ 3/ 4/ 10 12 1/ 2/ 3/ 4/ 5/ 6/ 7/ 8/ 9/ 1/ 2/ 3/ 4/ Source: Harris Williams & Co. compiled from third-party sources Source: Harris Williams & Co. compiled from third-party sources Top trends in middle-market private equity 3
  6. 6. not disclosed, but the Dealmaker While private equity deals smaller Figure 1.4 Figure 1.5 estimates the price tag to be a bit over than $750 million experienced a less sharp Private equity volume Private equity volume $100 million, which pales in comparison decline in the number of deals than the for deals less than for deals larger than $750M $750M to Carlyle’s $6.3 billion Manor Care deal larger-size deals market, total deal volume last year. The Authentix deal was is down from a year ago (see Figures 1.4 No. of Value No. of Value completed using capital from its Carlyle and 1.5). Overall in 2007, private equity deals (millions) deals (millions) U.S. Growth Capital fund, while the firms put $474.8 billion of capital into 2000 179 $20.1 2000 13 $ 19.8 Manor Care deal was completed using the U.S. deals, marking the third straight year 2001 84 5.3 2001 5 6.2 firm’s main buyout fund. This would of record volume. For the first half of 2002 75 6.8 2002 11 21.9 2003 82 7.9 2003 8 13.5 seem to indicate that Carlyle has been 2008, a paltry $63.2 billion of U.S. deal 2004 110 15.9 2004 31 56.7 focusing more on its growth buyout volume was recorded (see Figure 1.6). 2005 137 24.8 2005 29 87.5 practice rather than its large buyout fund “It’s still a good time for clean 2006 153 24.6 2006 66 349.1 2007 140 25.4 2007 53 289.3 for which it is more widely known. companies to sell in the middle market,” 2008 50 6.9 2008 9 13.9 Other large private equity firms have says Mark Jones, a partner with River decided to raise dedicated middle-market Associates Investments LLC. “If the Source: Thomson Reuters Source: Thomson Reuters funds for the first time. At the beginning companies are of real quality, the debt of the year, TPG Capital raised $1.2 sources are there. In fact, it’s a good time billion to invest in middle-market for traditional debt players, as well. It’s Figure 1.6 Private equity deals completed and funds buyouts. And in April, Silver Lake held a less competitive for them without all the raised through June 13, 2008 final closing of Silver Lake Sumeru, its CLOs [collateralized loan obligations] inaugural middle-market investment fund, and BDCs [business development 2007 2008 Billions with $1.1 billion of equity capital companies] that private equity firms were Deals $474.8 completed 63.2 commitments. using. Mezz guys [mezzanine investors] “Getting out of your comfort zone is are a lot busier and getting involved in Buyout funds $292.2 raised 133.6 a formula for disaster,” says Jay Jester, a larger transactions these days, but at very managing director with Audax Group. safe multiples. There are opportunities in Source: Thomson Reuters “A couple of the megafunds will put some the middle and lower ends of the market.” dollars to work on smaller deals, but Even though middle-market firms are when the market comes back, they will best at weathering the storm, deal Most of the decrease in activity has leave. I prefer to focus on the 300 to 400 professionals are certainly feeling less come from the large market. As a result of formidable middle-market firms that optimistic. According to the December large-market firms’ inability to access debt really present competition.” 2007 ACG/Thomson Financial survey, to complete megadeals, many of them With larger competitors moving into dealmaking professionals were less have moved downstream. However, not their turf, a flight to quality and harder- optimistic about the strength of the M&A all mega-firms are taking the same to-come-by debt (see Figure 1.7), middle- market at the end of 2007 than they were approach. For example, The Carlyle market dealmakers are feeling pinched. earlier at midyear 2007. Thirty-eight Group partnered with J.H. Whitney & percent of survey respondents rightly Co., a middle-market buyout firm, to buy expected transaction levels to drop in Dallas-based Authentix, which develops 2008. That was more than double the and delivers authentication and brand number of respondents who in August protection devices. Financial terms were 2007 thought levels would drop at the same time last year. To be fair, last year’s Figure 1.7 survey was taken when dealmakers were Average leverage as a multiple of EBITDA for middle-market LBO deals still in a hot M&A market and the drop- For the years ended Dec. 31, 2001-07 and Q1 2008 off had not yet hit, whereas the May 2008 7-year average: 4.3x 5.6x ACG/Thomson Reuters survey was taken 4.7x 4.7x 4.5x 4.3x 3.8x as we continue to be, arguably, in the 3.8x 3.4x worst of it. 2001 2002 2003 2004 2005 2006 2007 2008 Total debt Source: S&P Leveraged Loan Review 4 Top trends in middle-market private equity
  7. 7. Some private equity firms have set Figure 1.9 their sights on smaller deals, as well. In SF BDC price index two-year performance April, Norwest Equity Partners bought As of May 30, 2008 Shock Doctor, a sports protection Millions equipment company. The property was 200 acquired exclusively with equity provided 190 by Norwest and the management team. 180 The price tag was below what Norwest 170 usually pays for a deal, making it possible 160 to get the deal done debt free. The type of debt available for deals has 150 also changed radically over the past year. 140 There’s been an enormous contraction in 130 the pool of debt buyers for new issuances, 120 particularly among collateralized debt and 110 loan obligations. According to Standard 07 06 8 07 7 6 06 8 7 7 /0 5/ /0 /0 /0 /0 5/ /0 4/ 6/ 16 /0 23 28 22 13 /1 04 & Poor’s, in the first half of 2008, /1 /0 10 5/ 2/ 7/ 12 2/ 7/ 5/ 12 10 collateralized debt obligations (CDOs) Source: Factset fell for the first time since 2004. What’s more, Lehman Brothers estimated there would be only $30 billion to $35 billion in new CLOs issued in 2008 — a 60 percent Figure 1.10 Performance of top four BDCs from January to May 2008 drop from 2007 levels. As of April 2008, the number of U.S. Total return 1 2 1 3 5 QTD YTD (millions) month month year year year CDO managers on the league tables, which include CLO issuance, was small, BDCs ~500+ million market cap with only five banks issuing deals, ALD Allied Capital -21% -17% -44% -21% 6% -10% -20% ACAS American Capital -5% -15% -29% 10% 73% -12% -6% according to Thomson Reuters AINV Apollo Investment Management 2% 17% -18% 32% - 9% 4% (see Figure 1.8). ARCC Ares Capital Corp. 1% -8% -26% -10% - -5% -15% Source: Stifel Nicolous BDCs appear to be out of favor. At the same time that BDCs started Figure 1.8 Depressed valuations of publicly traded on a downward spiral, the Financial Collateralized debt obligations for Q2 2008 BDCs, which were once a strong source Accounting Standards Board (FASB) Name Market No. of Total of debt financing for middle-leveraged implemented the fair value accounting share deals issuance buyouts (LBOs), are also gone (see rule FASB 157, which requires the BDCs (billions) Figure 1.9). to set the value of their private portfolio Citigroup Global 38% 5 $2.3 By the end of May 2008, almost every companies to fair value based on public Morgan Stanley 21% 3 1.3 single BDC was trading below its book market data or other market comparables. JPMorgan Securities 21% 3 1.2 Barclays Capital 10% 1 .608 value as investors anticipated write-downs Many private firms are anticipating write- Lehman Brothers 10% 2 .605 (see Figure 1.10), according to an index of downs as a result of the poor performance BDCs compiled by analysts at investment of BDCs due in part to the impact of Source: Bank Loan Report/Thomson Reuters bank Stifel Nicolaus. A depressed stock FASB 157. price makes it difficult for BDCs to originate new loans, drying up more liquidity in the middle-market debt arena. Top trends in middle-market private equity 5
  8. 8. seeing an uptick because of that. There’s In fact, several BDCs are faced with Figure 1.11 also been a resurgence of mezz in the the prospect of running out of capital in Mezzanine funds raised 2000 through Q1 2008 market. But you can’t get the mezz the near future. For example, as of press Fund raised No. of funds without the senior debt first.” time, if Apollo Investment Corp. (millions) The last result of the credit crunch we followed its historic investment pace, the 2000 $ 7,488.2 38 will discuss is that it has given strategic BDC was facing the prospect of having 2001 11,130.9 25 buyers a chance to get back in the game. less-than-desired investment funds by 2002 2,636 25 According to Harris Williams, strategic March 2009, according to Stifel Nicolaus’ 2003 5,423.1 28 2004 4,613.7 32 buyers remain aggressive for quality estimates. Meanwhile, as of press time, 2005 8,958.6 42 assets. The firm has seen a significant MCG Corp. was virtually out of capital, 2006 1,7474 46 increase in strategic buyer interest in while Ares Capital Corp., operated by 2007 17,167.2 44 2008 18,186.8 11 recent months. The firm, which has Ares Management, was looking at hitting historically sold about 50 to 60 percent of its ceiling by the end of 2008. American Source: Thomson Reuters its client companies to strategic buyers, Capital Strategies had enough funds to has sold more than 70 percent of its client last into the beginning of 2009. companies to strategic buyers since “Nearly all the BDCs are trading December 2007. “We expect to see more below book value, and it’s much more Indeed, the trouble in the credit activity from the strategics in coming difficult for them to raise capital,” says markets has turned out to be good for months,” says Hiter Harris, co-founder of Greg Mason, a senior equity analyst traditional mezzanine lenders in the Harris Williams (see Figure 1.14). covering BDCs for Stifel Nicolaus. “The marketplace. As Figure 1.11 shows, the BDCs would be putting the money to amount of mezzanine capital raised in the work if they weren’t so constrained, but first half of 2008 was at $18 billion, new capital is very expensive, which is $1 billion more than the amount of capital forcing the BDCs to slow their debt raised in all of 2007. The percentage of Figure 1.14 investments into private equity deals. We mezzanine going into deals has increased, In the next six months, what is the greatest expect the BDCs to remain under this as has the equity contribution (see Figure opportunity for liquidity events for your portfolio companies? pressure for at least the rest of 2008 and 1.13). Reliable senior lenders are also in into 2009.” demand these days (see Figure 1.12). As a result of the issues BDCs are Andy Steuerman, a senior managing Sale to strategic facing, mezzanine debt has become more director with Golub Capital, explains, buyer 72% prevalent. “Mezzanine partners that have “We have been very active on the senior Sale to proven out their willingness and side because we continue to raise more financial partnership mindset are at a premium capital and we have stuck by our buyer 22% these days,” says Audax Group’s Jay relationships and supported the firms that IPO 3% Jester. “People aren’t looking for the very have supported us. It’s hard to find a Other 3% cheapest dollar anymore.” reliable lender these days and we are Source: ACG Thomson Survey Figure 1.13 Figure 1.12 Equity contribution Average purchase price and equity contribution by sponsor For the years ended Dec. 31, 2000-07, and Q1 2008 For the years ended Dec. 31, 2000-07, and Q1 2008 50% Senior debt Sub and other debt Equity 9.3x 8.5x 45% 8.4x 8.1x 3.4x 7.2x 7.0x 6.9x 6.7x 3.4x 40% 3.3x 5.9x 3.9x 2.9x 0.5x 2.9x 3.2x 2.9x 0.5x 2.5x 0.6x 35% 0.5x 0.9x 0.9x 0.7x 0.9x 0.8x 5.4x 4.1x 4.6x 30% 4.0x 3.5x 3.1x 2.6x 3.1x 2.9x 25% 2001 2001 2002 2003 2004 2005 2006 2007 2008 2000 2001 2002 2003 2004 2005 2006 2007 Q1 2008 Source: Harris Williams & Co. compiled from third-party sources Source: Harris Williams & Co. compiled from third-party sources 6 Top trends in middle-market private equity
  9. 9. The explosion of cross-border activity Figure 2.1 Figure 2.2 Office locations of the five largest private equity firms Office locations of the five largest middle-market private equity firms ● ● ● ● ●● ●● ●● ● ●● ●● ● ●● ● ● ●● ●● ●● ● ●● ● ● ● ● ● ● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● Firms represented ● Firms represented TA Associates The Carlyle Group Sun Capital Partners Warburg Pincus American Capital Strategies The Blackstone Group Advent International KKR Riverside & Co. Bain Capital Cross-border M&A has become an Going global is not new. Large-market increasingly vital part of strategic plans for U.S.-based private equity firms started middle-market companies and private opening up offices overseas to pursue equity firms. Large U.S.-based private opportunities in the late 1990s. Today, the equity firms have already proven that five largest private equity firms cover the doing business in different parts of the world with offices (see Figures 2.1). U.S. world often equates to success in today’s middle-market firms have taken this cue rapidly growing global economy. Reasons and have also started expanding globally to go global include the need for (see Figure 2.2). geographic diversification, the availability of good acquisition candidates in places outside the United States, the need to outsource divisions of portfolio Cross-border M&A has become an increasingly vital part companies to places where there are of strategic plans for middle-market companies and private cheaper labor costs, and the continued equity firms. consumer growth in emerging markets. Top trends in middle-market private equity 7
  10. 10. Figure 2.4 Figure 2.3 Private equity deals completed and funds Cross-border M&A volume raised through June 13, 2008 Rank value in millions Percent of global 2007 2008 Billions 50% $1,500 Deals $474.8 45% $1,200 completed 63.2 40% $900 Buyout funds $292.2 35% raised 133.6 $600 30% Source: Buyouts $300 25% $0 20% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007* *Ending June 30, 2008 Source: Thomson Reuters Figure 2.3 illustrates the proliferation Figure 2.5 Figure 2.6 of cross-border M&A activity over the Where do you expect most cross-border Private equity volume by U.S. firms outside past 10 years. There has certainly been a activities to take place? of the United States decline in U.S. private equity deal flow Value ($ billions) No of deals Western Europe 59% (see Figure 2.4) making overseas activity Canada 38% more attractive. According to the May 2000 $ 27 240 2001 21 150 China 28% 2008 ACG/Thomson Reuters survey, 28 2002 29 126 percent of middle-market firms say their United States 25% 2003 45 185 firms participated in a cross-border deal in 2004 61 255 Latin America 20% 2005 78 288 the first half of 2008, and more than 55 India 19% 2006 131 362 percent of respondents say their firm is 2007 194 486 Eastern Europe 16% likely to complete a cross-border deal in Middle East/Africa 11% Source: Thomson Reuters the next six months. Additionally, more Other 25% than 40 percent of respondents say that cross-border deals will become Source: ACG Thomson Survey increasingly more important to their firms over the next few years; 20 percent of respondents believe the best way to “There’s still a market for any kind of weather the current environment in the company anywhere, but the private United States is to diversify equity firms that have the foresight to go geographically. Figure 2.5 shows where to areas where there is higher growth and middle-market private equity firms mitigated risk will do well,” says Michael believe they will be active in the next six Gibbons, a senior managing director at months. Brown, Gibbons, Lang & Co. “A great What’s more, private equity deal number of firms are doing cross-border volume by U.S. firms outside the country deals. We recently did a deal in Hungary reached $194 billion in 2007, the highest for The Riverside Co. and one in ever, and that trend is expected to Germany for Sun Capital. We will continue (see Figure 2.6). continue to see this type of activity.” 8 Top trends in middle-market private equity
  11. 11. Figure 2.7 lists select activity by U.S. Figure 2.7 private equity firms overseas since the Select list of U.S. private equity firms that have participated in cross-border activity since the beginning of 2008. beginning of 2008 The list — small, but telling — Firm Funds raised Office opening suggests that firms are rushing to get overseas. However, the two areas in which Acon Investments Mexico and Brazil U.S.-based firms have the most interest Bear Stearns Cos. and Chinese bank Citic $1 billion Asian joint venture are China and India. Developing Securities Co. countries, particularly the BRIC countries (Brazil, Russia, India and China), present Brysam Global Partners new private equity firm unique opportunities to access growing €1.06 billion Englefield Capital new markets. Although Asian investment was once considered principally a means Arsenal Capital Shanghai of enhancing manufacturing potential for Sun Capital Partners $6 billion fund Tokyo products destined for Western markets, the vast markets that these economies JPMorgan Stockholm, Sweden represent cannot be ignored. Although H.I.G. Capital London China is geographically smaller than the United States, its population is three to Morgan Stanley $1.5 billion Asia four times greater: about 1.3 billion. Global Infrastructure Partners Hong Kong Imagine a potential middle-class consumer market equal to the entire Baird Private Equity China population of the United States, and you Morgan Stanley India can easily see why investors view China and other Asian countries as a market €1 billion Summit Partners European private equity fund opportunity rather than simply a place for low-cost manufacturing (see Figure 2.8). Sun European Partners Paris and Frankfurt The same can be said for India and other Note: As of press time, not all firms raised a dedicated fund in conjunction with opening an office overseas. developing countries. Source: Grant Thornton Research “There has been a lot of buzz around India and China for several years,” says Dennis White, a corporate partner in the Boston office of McDermott Will & Emery LLP and vice-chairman of ACG. “People are very interested in those Competition for good acquisition Figure 2.8 regions, and things are starting to happen. targets in the United States has been fierce What are the reasons for going to China? But there’s still a larger volume of cross- and has become even more so in the new Produce or source goods or services in China border activity in the UK, Europe and environment. Competition has led to for the China market 51% Canada.” McDermott Will & Emery more firms looking at cross-border deals; Produce or source recently initiated an alliance with MWE having an actual footprint abroad is goods or China Law in Shanghai to meet the needs services in something most firms believe is China for the of their clients. “Everyone is looking for important. U.S. market 16% opportunities anywhere they can find them,” says White. Produce or source goods or services in China for other (non-U.S./non-China markets) 8% Import into China 19% Other 6% Source: 2008 AmCham Business Climate Survey Top trends in middle-market private equity 9
  12. 12. Best practices To support all the cross-border Figure 2.10 “There’s an invaluable benefit of having a activity and globalization, many service Private equity deal volume by all local presence,” says Steve Collins, a providers have also opened offices around private equity firms outside U.S. managing director with Advent the world. Lincoln International opened Value Deals International. “It’s hard enough to get a eight new offices recently: five in Europe, (billions) deal done in a country where you know the latest in Madrid. Meanwhile, 2000 $ 60 1,347 the local customs and laws — forget about Houlihan Lokey opened a Tokyo office. 2001 61 1,058 a foreign country. Not all markets need a Proskauer Rose opened an office in 2002 68 859 2003 101 1,165 local presence, but most do.” Brazil, and Simpson Thacher moved into 2004 145 1,506 White agrees. “It’s easier to do deals in Beijing. Heller Ehrman LLP opened in 2005 204 2,020 the UK than in China,” he says. “There London — its first European office and its 2006 356 2,515 are varying degrees of a presence needed. fourth outside of the United States. 2007 408 3,082 2008* 71 791 Having a presence on the ground and Kirkland & Ellis LLP opened an office in relationships with local banks and firms Hong Kong and Grant Thornton has a *Ending April 2008 can make all the difference. The customs presence in more than 100 countries: 60 of Source: Thomson Reuters and cultural issues can make a big these member firms have experienced difference in getting a deal done.” local M&A professionals serving clients. Figure 2.11 The opportunity available in Still, the pendulum swings in both Non-U.S. based private equity developing regions is not just for U.S. directions. While there has certainly been fundraising private equity firms. In the past year, a push for U.S-based private equity firms Fund raised Deals many European-based firms have also to move overseas, many private equity (billions) moved into the growing territories. firms located outside the United States 2000 $26 101 Figure 2.9 lists non-U.S. firms that have decided to move in to take advantage 2001 25 89 recently have opened offices in of the weak dollar. Cinven, BC Partners, 2002 17 76 different regions. CVC Capital Partners, Permira and 3i 2003 27 76 2004 23 91 Group all opened offices in New York 2005 66 105 during the past few years. The presence of 2006 91 133 these new offices underscores a deal trend 2007 75 118 2008* 22 34 that has been growing for at least five Figure 2.9 Select list of non-U.S. firms that have opened years: European private equity firms are *Ending April 2008 offices abroad hungry for North American targets. For Source: Thomson Reuters example, in 2003, European private equity Firm Office opening/ country of deal firms paid $622.7 million for a total of 23 U.S.-based companies, according to Impact Adveq Beijing Champ Private Equity Singapore Private equity firms and companies that Thomson Financial. Last year, that Istithmar Shanghai support the private equity industry are number grew to $27.7 billion for 63 U.S. Candover Hong Kong expected to continue opening offices all targets. Bridgepoint Poland FountainVest China over the world. Most private equity firms “With the depressed U.S. dollar, it Ontario Teachers’ Pension Plan London will wind up being global to some degree. makes sense for firms to have interest in “The private equity industry is centered in U.S. targets,” says McDermott Will & Source: Grant Thornton Research the U.S. and grew up in the U.S., but Emery’s Dennis White (see Figures 2.10 taking it beyond the U.S. is a natural and 2.11). extension of the industry,” says Advent International’s Steve Collins. “There may be a slowdown in the near term, but directionally, cross-border activity will continue to grow.” 10 Top trends in middle-market private equity
  13. 13. The proliferation of operational partners Twenty-two percent of respondents to the When Lincolnshire Management From the largest private equity shops May 2008 ACG/Thomson Reuters survey decided to hire James Binch as a senior like Bain Capital to the mid-market ones cite strategic investors as one of the operating partner and managing director, like Industrial Growth Partners, firms are greatest impediments to dealmaking the New York-based firm was looking for increasingly finding operations people today. Increased competition from someone who was a capable fixer of invaluable to their teams. strategics, coupled with the proliferation companies. After being a seller in the “A lot of firms are adapting an of private equity firms, have made wooing marketplace until mid-2008, Lincolnshire operating partner model,” says Brian management teams into a sale more decided it was time to become a buyer Korb, partner with Glocap, a private challenging than ever, especially for teams again; and having someone to help equity recruitment firm. “And not that plan on participating after the improve the performance of portfolio surprising, we have definitely seen an increase in the hiring of these types of buyout. Over the past couple of years, it companies made perfect sense. Prior to individuals. These partners come with has become more common for private joining Lincolnshire, Binch was president additional credibility and a network that equity firms to hire operational partners and CEO of medical component can add value in a number of ways. They in hopes of gaining a competitive edge. manufacturer Memry Corporation can help with deal flow, apply best According to the ACG/Thomson Reuters (AMEX: MRY). “What better person to practices across portfolio operations and, survey, about 80 percent of respondents hire than someone who has on-the- when necessary, they can even parachute believe there has been an increase in the ground experience,” says Bill Buttrick, in and run them.” number of private equity firms hiring communications director at Lincolnshire. Another reason for the proliferation operational partners. While these partners “It’s not primarily the sector experience of operational partners is the need for are not hired for their expertise with we’re interested in. Rather, we look for a private equity firms to really showcase private equity, firms expect them to have manager who is capable of getting on the their capabilities to sellers, especially in expansive knowledge of the sector they ground and figuring out what’s going on this environment. Many dealmakers worked in and be able to deliver added at a portfolio company quickly.” believe that an operating partner gives value to their portfolio companies. Lincolnshire is just one such firm that has hired an operating partner lately. See them the edge (see Figures 3.1 and 3.2). Figure 3.0 for recent examples of other “No matter how good an idea a firms that have hired operating partners. private equity professional has, the management team looks at a 40-year veteran’s ideas differently because they have sat in the same chair,” says Tim Many dealmakers believe DeVries, managing general partner at Norwest Equity Partners. that an operating partner gives them the edge. Top trends in middle-market private equity 11
  14. 14. Figure 3.1 Select list of U.S. operating partners hired from January to June 2008 Private equity firm New hire Previous position Private equity focus Advent International Pam Patsley First Data Corp. Financial services operating partners Arcapita William Miller Boston Consulting Group Strategic performance Arsenal Capital Partners Larry Resnick M&A Executive, Triumph Group Aerospace and defense Arsenal Capital Partners Anthony Giorgio Corporate Development, SYMYX Technology Specialty chemical and materials Blue Point Capital Thomas Cresante CEO Special Devices Blue Wolf Capital Van Walbridge CEO of Mobile Tool International Blue Wolf Capital Walter Stasik CEO of Genesis Worldwide II Calera Capital Paul Walsh EFund Corp. Business and financial services Calera Capital Clyde Thomas eFunds Corp. Business and financial services Calera Capital (Fremont Partners) Michael Murray Head of I-bank with Bank of America CCMP Capital John Bowlin Kraft Foods Consumer investments CCMP Capital Denny Shelton CEO of Triad Hospitals Health care investments DLJ Merchant Banking Neal Pomroy MD with Mercer Management Head of portfolio strategy Doughty Hanson & Co. Adam Black Associate Director KMPG Oversee sustainability matters Fidelity Equity Partners Gray Hall CEO of CeriCenter Inc. Genstar Capital Paul Clark CEO of ICOS Corp. Biotech investments Morgan Stanley James Howland President of Dun & Bradstreet Natural Gas Partners Jack Holmes Syntroleum Corp. Deal generation Navigation Capital Partners O.G. Greene CEO of Burroughs Corp., National Data Corp. Norwest Equity Partners Jeffrey Greiner Founder of Wessels, Arnold & Henderson Technology add-ons Pegasus Capital Advisors Steven Marton President of office products at Newell Rubbermaid Providence Equity Partners Barry Allen VP of operations at Qwest Communications Water Street Healthcare Partners Curt Selquist Johnson & Johnson Welsh Carson Anderson & Stowe Stephen Larned Chief Marketing Officer DigitalGlobe Welsh Carson Anderson & Stowe Daniel Lieber CEO of Union Site Management WL Ross & Co. John Kanas CEO of North Fork Bank Distressed financial services opportunities Source: Grant Thornton Research necessary. And it helps to have an Impact Figure 3.2 Private equity firms will continue to hire operational partner when you are trying Does having operational partners give MBA students and investment bankers, to buy a company. When there’s someone private equity firms an edge when looking for but they will increasingly seek out from your group who can prove they investments? veteran operational partners. They will have experience, management teams Yes, it continue to hire any professionals who appreciate that, and it adds to the chances demonstrates knowledge may make them more competitive, even if of working with them.” and it’s outside of what was once considered Additionally, operational partners can experience in certain the normal realm. cut to the chase, getting a job done markets “If an operational partner can make a quicker and with less trouble. “Firms 79% 5 percent to 10 percent impact on one of realize that to stay competitive in this No, it our businesses, that puts us at a huge current environment, they need to extract doesn’t really make a advantage,” says Norwest’s Tim DeVries. maximum value from their investments. difference 21% “Private equity has matured They can hire outside consultants, but it tremendously, and we all have to do a pays off to have tactical in-house advisors Source: ACG Thomson Survey better job. Every increment helps. Some you can also turn to,” says Glocap’s Brian Lincolnshire’s Bill Buttrick explains, operational partners help us with contacts Korb. “You can justify paying someone “It makes sense to have an operational or give CEOs advice or set a great team in $1 million a year if they are saving you partner. A private equity company may place. All of those things help us perform $10 million.” own 15 portfolio companies and half may superiorly.” run into the occasional trouble. You want the ability to air-drop someone in who can work with current management or in a worst case scenario, replace them if 12 Top trends in middle-market private equity