By Mark Cecil
2005 was a record-breaking year for fundraising, which means that funds are able to write bigger equity checks than ever before. This may partly explain some interesting year-end statistics: for large transactions, average debt multiples were down from 2004, while transaction multiples came in near or above all-time highs.
According to recent statistics from Standard & Poor’s Leveraged Commentary & Data’s, equity checks are rising or are at a least poised to increase. Even in a debt market that some describe as never having been better, debt multiples were either stagnant or shrunk compared to last year, while transaction multiples increased.
David Santoni, a managing director at Goldsmith Agio Helms, said equity contributions could be going up for a few reasons. First, firms are lowering their return expectations. Second, in some cases, the seller wants to get to closing quickly, so firms are putting up more equity at closing, then financing on the back end. To be sure, there is an abundance of equity in the market. Adam Sokoloff, co-head of Jefferies’s financial sponsors group, said “2005 was a record year for private-equity fundraising. As a result, there’s a lot of money sitting on the sidelines looking to be put to work.”
For transaction multiples-without fees-2005 smoked past 2004 and hit the highest levels in the past decade for smaller deals. For deals worth up to $250 million, average multiples hit 7.52x EBITDA, which is up from 2004’s figure of 6.79x EBITDA. That is also the highest year-end average since 1994, surpassing the 7x figure from 1998. For deals worth between $251 million and $499 million, multiples soared to 8.06x EBITDA, second only to 1998’s 8.33x in the last 10 years, and up over 2004’s 6.86x. For deals over $500 million, the average multiple rose to 8.42x, also second only to 1998’s 8.53x and up over last year’s 7.52x.
Debt multiples, meanwhile, either inched up or waned. For deals up to $250 million in 2005, the average debt multiple was 4.58x versus 4.4x in 2004. For deals between $250 million and $499 million, the average was 4.79x versus 4.7x last year. For deals between $500 million and $1 billion it was 5.04x versus 5.9x last year, and for deals above $1 billion the average debt multiple was 5.7x, compared with 6.06 last year.
Despite the numbers, many say they haven’t experienced a retraction inthe debt market. Ned Valentine, a managing director at Harris Williams, who looks at deals in the $100 million to $500 million range, said “We have not seen the debt market pull back at all. The debt market continued to be very strong and stable over the last 18 months in terms of multiples.” He added, “On the debt side, money is cheap and easy to obtain. There is a tremendous amount of liquidity. We don’t see anything in the debt market that would say they are changing their appetite to put money to work.”
John Sinnenberg, chairman of Key Principal Partners, offered a few anecdotes illustrating the fevered debt market in 2005, where he says multiples have likely peaked. First, he mentioned, half in disbelief, a debt financing at 5x he recently saw for a firm with $18 million in EBITDA. Then he recalled another instance of how KPP lost a transaction to a hedge fund that swooped in when KPP was in the midst of due diligence. The transaction process was designed to take six weeks-from start to close-but the hedge fund closed the deal in 10 days for 500 to 600 basis points less of a return than what KPP projected.
Jefferies’s Sokoloff has had similar experiences. In the retail and restaurant industries, for example, “we’ve seen leverage deals that we’ve never seen before. When you can put 6x EBITDA on a restaurant company, that’s probably close to two turns higher than a more normalized level over the last 10 years. And for some of the larger deals it’s been even higher.”
Hedge Funds Forge Ahead
Hedge fund activity, meanwhile, is seen by some as a risky choice to provide leverage. Santoni said one of the major things buyout shops continue to worry about is the effect hedge funds will have. They have been aggressive, but no one really knows how hedge funds will behave when things go sideways.
“Is it worth it to go to a hedge fund to get that extra half turn in a multiple?” wondered Santoni. “For private equity groups, it’s a risk-reward decision.”
Deal Multiples Add Up
Regardless of whether the lending market is very good or just plain good, deal multiples have taken off unconstrained. Just from the fourth quarter there were a number of deals with powerful multiples-often setting records in their industries.
Caxton-Iseman Capital agreed to sell its Anteon International division to General Dynamics for 13.2x forward EBITDA, said by the target’s banker to be the highest ever paid for a government IT contractor. Silver Lake Partners bought Serena Software for about 11x EBITDA, one of the highest ever for a tech LBO. Silver Lake was also part of the $11.4 billion buyout of SunGard for about 10x EBITDA earlier in 2005.
Also in the fourth quarter, in software, SS&C Technologies sold for $942 million to The Carlyle Group, at a multiple of 14x trailing EBITDA. The forward figure on the deal is 11.3x. Bain Capital, The Carlyle Group, Thomas H. Lee Partners agreed to buy the fast food chains of Pernod Ricard, including Dunkin’ Donuts, for $2.4 billion, a deal that reportedly included a stapled financing package at 8x EBITDA and an EBITDA transaction multiple of 12.8x. Blackstone’s $3.4 billion purchase of hotel operator La Quinta went for 13x EBITDA.
Valentine said the reason for the high deal multiples is simply the good performance of the targets. “And on the equity side, the fundraising has been massive.” There continues to be a trend of private equity becoming a more efficient asset class with the premium private equities to public equities getting closer.” Strategic buyers are very active right now, but private equity is right with them. “The mega funds, when they club, they bring quite a bang to the table and can be very competitive with a strategic buyer,” said Valentine.
And on the lower end, Valentine added, “From a valuation perspective, we’re seeing private equity buyers solidly in the 8x to 9x range for a $300 million asset.” Santoni, meanwhile, said he’s seen multiples in food and beverage at 7.5x to 8x, even for transaction sizes less than $250 million.
In the past year, “I would say we saw most really good, B+ quality companies go for north of 8x. Below eight there wasn’t the growth trajectory or the management team,” said David Barnes, a managing director in Houlihan Lokey Howard & Zukin. “The engine is just chugging away. Inflation hasn’t popped its head up. All the things that people are normally talking about [preceding a slowdown] haven’t happened yet. Right now the dynamics of 2006 are even better than 2005.”