Those Bulging Buyouts
Leveraged-buyout firms are on a tear. Sidelined by corporate buyers in the late '90s when merger mania pushed the prices of companies out of sight, LBO specialists are enjoying a revival that recalls their '80s heyday. Flush with $100 billion from deep-pocketed pension funds, they are winning deals that are bigger than anything they've done before, and they're often shoving corporate buyers out of auctions.
Indeed, the deals are getting so big that buyout kings are regularly teaming up with each other. In November, Thomas H. Lee Partners, Bain Capital, and Providence Equity Partners joined forces to back the $2.6 billion purchase of Warner Music Group by former Seagram chief Edgar Bronfman Jr. LBO firms -- private partnerships that use their funds as leverage to borrow huge amounts to do deals -- bought 13 U.S. companies valued at more than $1 billion in 2003, nearly double the annual average of seven companies over the past decade. Overall last year, LBO firms, also known as private-equity firms, accounted for 10% of the $540 billion in mergers and acquisitions announced in the U.S., double the average of 5% over the last 10 years, according to New York-based deal tracker Dealogic.
This year, they promise to be an even bigger force as the M&A market continues its revival. The fast-growing economy and the bull market in stocks are giving LBO firms a chance to fill their brimming war chests with yet more billions collected from companies they already own -- by either selling the companies or extracting big dividends from them. For example, Clayton, Dubilier & Rice will complete its sale of Kinko's to FedEx (FDX ) for $2.4 billion in cash in February. And Blackstone Group and two other firms paid themselves $450 million in dividends in January only two months after they had bought water-treatment-outfit Ondeo Nalco for $4.2 billion. Now that they're collecting such strong profits, LBO firms should be able to raise an additional $62.5 billion from investors this year, estimates Lawrence Schloss, head of private-equity investing at Credit Suisse First Boston.
The cash avalanche will help drive the size of LBO deals even higher, especially because still-low interest rates make financing dirt-cheap. Increasingly, buyout firms are targeting public companies and outbidding would-be corporate buyers in part because the hot junk-bond market makes it simple for them to borrow. "It wasn't always easy to invest in really good businesses, and the smart firms know to take full advantage now," says Jack Levy, head of M&A at Goldman, Sachs & Co. (GS ). "Add the tremendous amount of money the buyout firms have, and, voilà, you have deal combustion."
Wall Street is falling over itself to help the buyout artists. The lure? An estimated $2.8 billion in fees that LBO firms will pay this year for good ideas on what to buy in the U.S. and for help in arranging financing. Two years ago, those fees totaled just $2.1 billion, according to Banc of America Securities LLC Vice-Chairman Stefan M. Selig. Morgan Stanley (MBK ), for example, has resurrected an in-house think tank specifically to generate investment ideas for LBO firms.
OUTMANEUVERING TARGETS. The purchase of Warner Music, which Bronfman was able to snag despite a rival bid from recording company EMI Group PLC, shows just how powerful the buyout merchant's muscle has become. Typically, it has been difficult for financial firms to beat out corporate buyers. But Time Warner Inc. (TWX ) Chairman and Chief Executive Richard D. Parsons chose an LBO consortium over EMI to avoid potential antitrust issues. Bronfman and the three LBO firms backing him also gave Time Warner an option to buy back as much as 20% of Warner Music in the future. A corporate buyer such as EMI, purchasing the unit to expand its market share or boost earnings, likely would not have granted such an option. "I like to call it schmuck insurance," Parsons told BusinessWeek Online in December. "In case the music industry starts to go like gangbusters, we won't look like schmucks for selling."
LBO firms are increasingly outmaneuvering companies in part because they have become corporate buyers in their own right. Over the past two years, they have picked up companies selling everything from electricity to cat food. And now, they're using the companies they bought to buy yet more companies. For example, Warner Music is in the market to buy publishing catalogs to expand its Warner/Chappell Music Inc. unit. "All of our investments are looking for acquisition opportunities," says Anthony J. DiNovi, a managing director at Thomas H. Lee Partners LLP. Some LBO outfits are also hooking up with companies to scout out potential purchases. In April, Bain Capital entered into a $550 million joint venture with Omaha-based independent power producer Tenaska Inc. to buy power-generation assets.
The buyout kings have become such big players that often when they buy a company, they're purchasing it from another LBO firm. In 2003, a record 16% of companies worth more than $100 million apiece sold by buyout firms were bought by other such firms, according to Citigroup. For example, Warburg Pincus bought TransDigm Holding Co., an aircraft-component manufacturer and distributor, from Odyssey Investment Partners in June for $1.2 billion.
Of course, one result of the greater presence of financial buyers is that they're in a bigger hurry than companies to make money, and then move on. The LBO firms generally look for returns on their investments within three to five years. "We're not building a conglomerate," says Thomas H. Lee Partners' DiNovi. "We'll work with the management teams to grow companies' businesses, and we'll look to realize a return for our investors."
When Bronfman takes over as head of the world's third-largest record company in February, he'll enjoy anything but a free hand. The LBO firms will have board seats and a say on everything from obtaining bank loans to setting compensation and cutting costs.
Buyout firms are hiring more top names from Corporate America than ever. Former Ford Motor Co. (F ) CEO Jacques A. Nasser joined Bank One Corp. (ONE ) in 2002 as a senior partner in its private-equity business. He was promptly named chairman of Polaroid Corp., which the Bank One unit had bought out of bankruptcy in July of that year. And a retired chairman and CEO of Honeywell International Inc. (HON ), Lawrence A. Bossidy, sits on the advisory board of the Aurora Capital Group based in Los Angeles.
THE PRICE ISN'T RIGHT. They recruit seasoned managers for a simple reason: Buyout firms are struggling to squeeze higher returns from companies that have already adopted their slash-and-burn methods of management. "You have to have an answer for where the business is going and how you're going to create more growth," says Jonathan Weiss, head of the financial sponsor group at J.P. Morgan Chase & Co. (JPM ).
Some buyout kings could face tougher times. As the economy improves, corporations are becoming more aggressive buyers. And the stock market is already nudging prices of some companies up to unaffordable levels. "It doesn't matter how great a company is," says Hamilton E. James, vice-chairman of Blackstone. "If we can't buy it at a price that will earn us a return of at least 20% a year, much as we'd like to, we can't do it."
Still, there's plenty of scope for LBOs. Not every company in the U.S. has an obvious corporate mate -- especially in concentrated industries where antitrust concerns loom large. Besides, company executives say they don't feel threatened by the increasing presence of LBO partners in their boardrooms. "They expect us to get costs down for a challenged business while at the same time increase market share," says Bronfman. "We think we can do that." Who knows, maybe they will make beautiful music together.
By Emily Thornton in New York, with Ronald Grover in Los Angeles and Tom Lowry in New York