M&A Activity to Continue at Accelerated Pace

The merits (and demerits) of private equity have been debated by market participants, and unfortunately neer-do-well politicians in much of the first half of this year with a recent crescendo in the debate. I think this article highlights some of the dimensions around the issue and provides a number of useful data points. Though some of the frenzied activity especially regarding cov-light loans prompts some concern, the outlook, at least according to this article, is still optimistic. As always, leveraging a poor business with inadequate cash flows is an unmitigated disaster. The trick is always to buy a business utilizing leverage to achieve optimal capital efficiency in order to maximize return.

According to PWC, deals in the first five months of this year totaled $845 billion representing 10% more than the deal value for all of the first half of 2006.

Interestingly, private equity accounted for 48% of M&A value versus 32% of last year's comparable period.

A PWC partner, Bob Filek indicated that he believes this M&A market may surprise on the upside, noting, "History shows that default rates trend up as the peak of M&A activity approaches, but default rates are still holding at moderate levels. While a liquidity crisis or rapidly rising interest rates could change that in a hurry, things look strong into '08." Currently, the default rate on U.S. speculative-grade loans remains at its lowest level since the early '80s-1.3% compared with 1.9% last year. However, 50% of all new high yield debt issued in the first two months of 2007 was rated B- or lower, compared with 32% in 2006 and 36% in 2005, according to Standard & Poor's Global Fixed Income Research. The average size of the most speculative loans has increased to $581.2 million in 2007 from $351.6 million in 2005. The vast majority of defaults over the last 70 years have been speculative grade loans."

At a time when there is growing doubt about the continuation of these trends, the article predicts that, "any eventual slowdown is likely to be a soft landing, rather than a hard crash like the one occurring in 2001. Large private equity funds, which are more diversified than they were at the start of the decade, are well positioned to profit from a downturn. While buyouts may eventually slow and returns upon exit may be lower, other private equity transactions such as distressed debt deals and workouts are likely to increase. Other market dynamics that will cushion any slowdown include diverse and expanded funding sources for M&A, a steady stream of targets for both value and growth plays, and the many roles hedge funds are playing in the M&A market."

Here is a link to this very interesting article:

abfjournal.com ...dedicated exclusively to the asset-based lending industry

For a completely different point of view, please check out a Wall Street Journal blog post from yesterday: Is Private Equity Out of Gas?