Private Equity's Big Winners

The biggest deals in 2006 were in real estate and health care. Next year, buyout firms will be more active in tech and media

The private equity sector expanded its influence in 2006, making deals in relatively new areas of interest such as media and technology.

In the past, those sectors were often considered too volatile for buyout companies, which tend to prefer targets with stable cash flow. Two factors changed during the past year. Sectors such as semiconductors and media are benefiting from new business opportunities driven by wireless technology, the spread of communications technology globally, and the Web. That has helped persuade investors that there's a promising future of growth and rising cash flow. In addition, leveraged buyout firms such as the Blackstone Group, the Texas Pacific Group, and Thomas H. Lee Partners have raised more money than ever before, allowing them to make plays they couldn't have contemplated in the past.

Media, Tech, and Health Care

That enabled private equity firms to shift their emphases in 2006. During 2005, private equity buyers focused on areas such as retail. Kohlberg Kravis Roberts took out Toys "R" Us for $6.6 billion, and a group including Texas Pacific bought Neiman Marcus for $5.1 billion. "There were retail deals in 2006, but much of the emphasis shifted to sectors such as media, technology, and health care," says Richard Peterson, a senior analyst at market researcher Thomson Financial (TOC).

Media and tech were hotter than ever. Blackstone and other private equity firms bought semiconductor maker Freescale for $17.6 billion. Lee and others bought Spanish-language media giant Univision for $13.7 billion. Lee, KKR, Blackstone, and others bought media empire Clear Channel Communications for $18.7 billion.

The biggest deals were in health care and real estate, though. KKR and others bought hospital company HCA for $33 billion, breaking the $30.6 billion LBO record that KKR established in 1988 with its takeover of RJR Nabisco. The record was broken again when Blackstone and other investors bought Equity Office Properties Trust for $36 billion.

Media Behemoths?

Looking ahead to 2007, the same private equity themes are likely to be amplified. Private equity buyouts will get ever larger, as pension funds continue to allocate more capital to the big private equity players. Investment bankers, who declined to be identified, say private equity firms can manage deals of $50 billion or more (see, 12/19/06, "Deals of the Year, in a Year of Deals"). As private equity buyers figure out ways to finance ever larger deals, they may have a crack at huge tech and media targets such as Time Warner (TWX) or Viacom (VIA).

The tech sector likely will see more buyouts. They will grow in magnitude, too. One investment banker, who spoke on condition of anonymity, said large semiconductor companies could make attractive private buyouts. Is Intel (INTC), with a market cap of $117 billion, too large to digest? Probably, but companies such as Texas Instruments (TXN), with a market cap of $43 billion, would be manageable.

Private equity accounted for just 4% of mergers and acquisitions during 2000, the last market peak (see, 12/26/06, "I-Banks Jockey for Position"). It accounted for 17% of deal volume in 2005 and 19% of deal volume in 2006. The industry has become more attractive because the returns of the top-performing funds beat the public by a long shot. The megafunds have returns of 40% or 50% or more.

While that may drop down into the 30% range, it still beats the stock market. The high returns reflect the fact that private equity funds have access to the cheapest capital.

Concentration of Capital

Private equity spending power is concentrated in relatively few hands. The biggest firms tend to have the best results, which means that they can raise the most capital and win the most deals. Texas Pacific Group did the most business in 2006, participating in 17 deals worth a total of $101 billion, according to Thomson. Blackstone followed with 19 deals worth $93 billion, and Bain Capital Partners came in third, with 12 deals worth $85 billion. KKR was fourth, with 13 deals worth $78 billion, and Carlyle Group was fifth, with 31 deals worth $72 billion.

The private equity business will continue to transform Wall Street, too. Investment bank Goldman Sachs (GS) reported a $9.5 billion profit for its fiscal year, an industry record. It attributed much of its success to alternative investments such as private equity. Revenue from private equity and related markets rose 64%, to $1.4 billion, while the more traditional investment banking business rose 42%, to $1.3 billion (see, 12/13/06, "All That Glitters Is Goldman"). Goldman ranked seventh among private equity players, with five deals worth $53 billion.

Attracting Attention

Just after Goldman among the ten most active private equity players in 2006, was Apollo Management. It had nine deals for the year, worth $49 billion. Cerberus Capital Management ranked ninth, with nine deals worth $34 billion. And at No. 10 was Merrill Lynch (MER), which participated in two deals at a total of $32 billion.

As the year closed, private equity firms took perhaps the ultimate step toward joining the business mainstream. On Dec. 26, 11 firms formed a Washington lobby group, The Private Equity Council. Private equity firms have begun to come under closer scrutiny, as the size of deals they pull off has soared and the amount of money they wield has grown. Success always comes with a price. In this case, it's attention.

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