Fresh Barbarians at the Gates?

Private-equity firms are eyeing some very big targets. Deals for Time Warner, Vivendi, or Unilever would easily eclipse RJR Nabisco's long-standing record

The pace of change on Wall Street is fast and furious, and few records hold for long. Yet after 18 years, Kohlberg Kravis Roberts & Co.'s (KKR) $31.4 billion acquisition of RJR Nabisco in 1988 remains the largest buyout of a company ever by a private investor.

Now, however, it looks like that record could be broken, probably within the next year. The global private-equity sector has more than $300 billion in cash. Given its ability to borrow against that capital, private-equity funds worldwide have more than $1 trillion in spending power, according to John O'Neill, a partner with Ernst & Young Transaction Advisory Services in New York. "I think we will see larger and larger private-equity deals, and that the RJR Nabisco record will be broken," says O'Neill, who helps big private-equity firms analyze the value of potential deals.

The value of the typical private buyout already is on the rise. Until recently, leveraged buyouts typically involved manufacturing companies, retailers, and other consumer-products companies with a value of $1 billion or less.

But deals in the $5 billion-to-$15 billion range have become commonplace. Last fall, Ford Motor Co. (F) sold its Hertz rental-car division to a group of private investors including Clayton, Dubilier & Rice, The Carlyle Group, and Merrill Lynch Global Private Equity for $15 billion. A private-equity consortium including The Blackstone Group, KKR, and Thomas H. Lee Partners is completing a $9.7 billion buyout of Dutch information giant VNU, which runs the Nielsen media ratings service. Last spring, a group of private-equity investors including Silver Lake Partners, Blackstone, and KKR, acquired SunGard Data Systems for $11.3 billion.


  The value of deals is rising for several reasons. The main reason is that a booming global economy has generated lots of cash to be invested, but returns in the public markets haven't been great. Institutional investors, including public and private pension funds around the world, are putting billions into private equity.

While the days of 30% returns largely have passed, private-equity funds still generate annual returns of 15% to 20%, or more. And in an era of increasing pressure from regulators and intense demands from hungry investors, management often sees a value in going private (see, 3/29/05, "The Allure of Going Private").

The structure of the private-equity business has evolved in ways that accommodate larger deals. When the private-equity business got going 30 or so years ago, firms didn't work together on deals the way they do now. But the rise of "club deals" including five or six players is common. Hertz, SunGard, and VNU are a few examples. The private-equity sector is starting to boost its buying power by working with large publicly traded companies to make acquisitions, according to O'Neill, of Ernst & Young. One recent example is this year's $17.4 billion acquisition of Albertsons by Supervalu (SVU), CVS Corp. (CVS), and Cerberus Capital Management.

It still won't be a cinch to eclipse the RJR benchmark. It was easier to wage a massive takeover in those days because buyers were allowed to put relatively small amounts of equity into their deals. KKR acquired RJR for $31.4 billion, and took on an additional $6.3 billion of the company's debt. KKR put $3.6 billion in cash, or 11.5% of the purchase price, into the deal, borrowing the rest. Today, buyers are required to put up 20% to 30% in cash.


  Given today's lending practices, it's a challenge for a consortium of large private-equity investors to assemble enough cash to make an RJR-sized acquisition, according to Hamilton E. James, president of The Blackstone Group. Private-equity funds, he says, typically won't put more than 10% of their money into a single investment.

The largest funds, which are run by Blackstone and Texas Pacific, are about $14 billion in size. That means they are unlikely to invest more than $1.4 billion each in a given deal, if that. Most of the other big funds are in the $10 billion range, which means they can invest $1 billion or so in a single deal. The $11.3 billion SunGard deal, which included seven leading private-equity firms, included only $3.5 billion in cash.

The math is pretty clear. It would take a particularly large consortium of more than six firms to put up a total of $6.5 billion in equity, and then borrow another $26 billion or so, to surpass the RJR Nabisco mark with a $32.5 billion deal. "The bottom line is that we probably will see deals bigger than RJR getting done over the next year or two," James says. But he doubts there will be more than a few. "The action is lots of deals in the $5 billion to $15 billion range," he says.

Which company could be the one to break the longstanding record? Here are five possibilities that might be attractive to private investors. This isn't to suggest that these deals are in the works. Rather, they are illustrations of the kinds of deals that could make sense.

Vivendi (V)

In May, the French media company received an unsolicited takeover bid from Sebastian Holdings, the private-equity company controlled by Dutch investor Alexander Vik (see, 5/17/06, "Private Equity's Media Targets"). He has offered $50 billion for Vivendi, which owns Universal Music, NBC Universal TV, and the Canal Plus TV business in France. Vik wants to break up the company into separate pieces.

With a market cap of about $40 billion, or half its peak, the company has generated enough investor dissatisfaction to arouse the interest of private-equity investors who think they can turn the operation around and make a profitable exit a few years hence. And with a bid of $50 billion, Sebastian Holdings already has demonstrated that private-equity investors are confident that they can handle deals of unprecedented scale and scope. Vivendi passed on the offer, but the gauntlet has been thrown.

Time Warner (TWX)

Financier and shareholder activist Carl Icahn tried to break up the Time Warner media empire over the winter. He failed. But CEO Dick Parsons only has bought himself a limited amount of time. If the share price doesn't pick up significantly during the next year, he could face another takeover bid. With a market cap of $72.5 billion, Time Warner would be a bit much for any group of financial investors to swallow whole. But a deal could be easier if Time Warner decides to spin off its cable-TV systems.

There's an internal debate on that topic inside the company right now, according to people familiar with the matter. Parsons is said to want to hold onto the cable unit for business reasons. But other executives such as President and COO Jeffrey Bewkes are said to be more receptive to the idea of splitting off the cable TV systems unit. If they prevail, a takeover of the remaining Time Warner empire could be more feasible.

And private-equity companies already have shown an affinity for media. Spanish-language media company Univision (UVN) is being acquired in a buyout. Emmis radio was taken private as well during the last year.

Deutsche Telekom and British Telecom

The telecom sector could be fertile ground for massive leveraged buyouts. The industry has a significant cash flow, although equity values have suffered for years because of competition. A private-equity investor might see an opportunity to buy at an attractive price and cut costs to maximize cash flow in a business where revenue is on the decline.

Telecom could be a natural fit for private equity. The cash flow allows private-equity investors to put more debt on an acquired company, which boosts their return. The cash raised in a debt offering can be used to make acquisitions or to issue more dividends. The holders of the debt then purchase more equity in their own company, so they can collect the dividend that's funded by the cash that their company has borrowed. Private-equity investors already have made bets on telecom. Carlyle bought phone lines in Hawaii from Verizon (VZ) (see, 5/11/06, "Verizon Mulls Cash for Its Lines").

Bigger potential targets might include European telecom giants such as British Telecom (BT) or Deutsche Telekom (DT). Deutsche Telekom has a market cap of $67 billion, and British Telecom has a market cap of about $35 billion. The telecom industry could be tricky for private investors because regulators might balk at the idea of a financial operator stepping in and loading up the phone company with debt. There also could be concerns about whether a private investor would make sufficient capital investments to promote the public good. Carlyle had a tough time winning approval for its deal in Hawaii.

Unilever (UN, UL)

With a market cap of $75 billion, the British and Dutch food and consumer goods giant also appears to be at the upper limit of what a private-equity consortium could handle. But the owner of brands such as Lipton, Knorr, and Hellmann's has a huge cash flow, and its consumer-products business is familiar territory for private-equity investors. Rumors of such a deal have been circulating for months. Investors have been disgruntled with the low share price and management has been under fire, much as it has been at Time Warner. The combination of a weak share price and a sound business with fixable problems could put it square in the sites of buyout firms.


  There's little doubt that private-equity companies can overcome the challenges and pull off a deal that eclipses RJR. But the key question is whether such a buyout will work. Most M&A experts say big mergers and acquisitions are the toughest to work. Companies like Cisco (CSCO) and Microsoft (MSFT) prefer to make smaller acquisitions.

Private-equity players may owe part of their huge recent success to the fact that they have acquired smaller and more manageable companies, with problems that lend themselves to solutions. Big companies, with all their complexity, could pose a challenge for buyers hoping for a profitable exit.

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