Private Equity Deal Activity Remains Slow

Although US private equity (PE) mergers and acquisitions (M&A) activity is still quiet, PE firms, armed with cash, continue to look for opportunities to invest, according to Ernst & Young LLP's 2009 U.S. PE report (available at: ey.com/us/privateequity). PE participation in minority stake deals is returning after taking a back seat in 2005 through 2007 a period during when mega-deals were in full swing. In addition, government reform in healthcare and financial services may present investment opportunities.
"PE firms are sitting on a large amount of available cash. However, leverage is still almost nonexistent which is hampering deal flow and cash deployment," said Gregg Slager, America's Private Equity Leader at Ernst & Young LLP.
Announced US PE deal volume fell 42% in 2008 compared to 2007. This downward trend has continued into 2009 with 314 transactions announced through May of this year, the lowest five-month volume since 2002 (see data charts at: http://www.ey.com/US/en/Services/Specialty-Services/Private-Equity/Announced-US-PE-Activity).
"The bid-ask spread -- the price buyers are willing to pay and the price sellers are willing to sell -- hasn't narrowed. Until it does, activity will be slow," Slager added.
According to Ernst & Young LLP's 2009 US PE report, although PE firms have historically experienced the best returns from investments made during a down market, PE will be slow in returning to the M&A arena until the credit and capital markets recover.
Read the full article herehttp://news.prnewswire.com/DisplayReleaseContent.aspx?ACCT=104&STORY=/www/story/07-23-2009/0005065044&EDATE=
NEW YORK, July 23 /PRNewswire/ --

The economy matters for private equity

I have been following Arnold on Twitter. You know, Arnold, ex-Terminator and now governor of California. He has been sharing his budget pain and what he is trying to negotiate.
California accounts for 10% of the U.S. economy. It's state budget is about $125 billion and the deficit is about $25 billion. By law, California must balance its budget each year and the fiscal year ends June 30. Back in February, the Democrat-controlled legislature could not agree with Republican Governor Arnold Schwarzenegger on spending cuts, but it did agree to put a series of tax increases and borrowing schemes before the voters in a referendum. On May 19, all were defeated. California treasurer Bill Lockyer appealed to Washington for access to bank bailout funds, but he was turned down. He has since warned that the state only has enough cash to meet payrolls until mid-summer. We are all watching.
California matters because of its sheer size on the U.S. economy, and because 49 other governors are watching to see how Washington reacts to its budget crises. State governments are contemplating layoffs, program cuts, tax hikes, facility closures and other such measures all of which will cut in U.S. employment and consumer spending in the third quarter. Over the summer we will learn how these issues play out.

Tips for strategy

As investors evaluate business plans there are certain tests to pass.
No matter the size of company, the first test (besides the people) is around the strategy. One thing I have learnt is that the right strategy is unknowable in advance.
I would far rather see that the company has a strategy to learn, rather than a strategy to implement.
All industries are ripe for disruption and that counts whether it’s banking, computers, brokerage, private equity or even the venture capital industry itself. The odds do favour the incumbent but when a “sustaining” technology is introduced, this has the potential to disrupt the current scene. As private equity fund managers know; disrupter companies can be a great investment.
So what makes a good disrupter? Some are obvious but others, not so much. Here's a quick rule of thumb: If the company’s technology gives skills to a less wealthy and skilled large group of people; it is a good indication that it passes the investor test.
The technology has a higher potential to take hold and gain market share. Now you are talking.
If I were to give some advice to “disrupters” or those wanting to be disrupters, it would be that if a business model seems unattractive to the current dominant players, and clearly is not a sustaining technology to anyone else, then you are cleared for a green light.
Time to go for it!
If you want to ponder more on disruptive strategies, I recommend any of Clayton Christenen's articles.

Are you naive about the recession's end?

So it's official - The Conference Board reported that the recession is over, but don't be too quick to think everything will be hunky dory, cautions The Gartman Letter:

Firstly, however, we shall note that The Conference Board reported its Leaders, Coincidents and Lagging Indicators yesterday, with the former rising 0.7%, almost spot on as had been expected. We note that this was the third month in a row of increases, and historically three consecutive months in a row of advances is the sign that the recession is about to end.

By definition, the “Leaders” lead, and so those reliant solely upon the Board’s Leading Indicators are not prepared to join us in our statement that the recession has ended.

We’re “OK” with that.
More importantly to us, the Board’s Coincident Indicators in June fell modestly, losing 0.2%, while the Laggers fell even more, losing 0.7%. Thus the Ratio of the Coincident to Lagging Indicators rose yet again, not by a material sum, but it rose nonetheless. This is our favourite economic data point, and it has now risen for two months in a row. Historically, it turns “spot on” the turning point of the recession, although it has fired off one or two false signals in the past. However, when the Ratio turns higher coupled with a “spike” downward in weekly jobless claims, the Ratio does a truly spectacular job of telling us that the economy is at its worst levels and that a turn higher is hard upon us.
It has turned higher; that is all we need or wish to know. What we must also remember, however, is that the economic news shall remain horrid for several months yet for we must always remember that the end of the recession means that we are at the nadir of the economy. Things are at their worst at the lows.

Consumer psychology is months, if not a full year, away from turning for the better. Retail sales will look terrible for months; housing sales, although rising from their lows, will still be hundreds of thousands of units in annualised terms below the decent levels of two and three years ago; auto sales will seem horrid in comparison to those of ’05 and ’06 and ’07; unemployment is heading inexorably toward 10% or higher and will continue to rise long into ’10, but the worst is probably upon us now and better numbers lie ahead.

Thus, those who think that just because we have called the recession’s end to be upon us means that we shall see remarkably strong economic data points immediately are naïve and out-of touch historically.

Thanks to Scott Tomenson, Family Wealth Management. You can see more of Scott at http://www.jstomenson.ca/ and also
http://familywealthmanager.blogspot.com/

Stories of Private Equity

When the announcer yelled out, “The winner of the Media category, Ernst & Young Entrepreneur of the Year—Somerset Entertainment!” Andy Burgess grinned and bounded up to the stage to collect the award.
It all looked so easy to be standing there in a tuxedo waving the trophy, but this moment of appreciation came from painful years of slogging late into the night.
Andy Burgess is one of the owners of Somerset Entertainment, which produces and distributes specialty music to gift stores and other non-traditional retailers using interactive displays where you can push a button and listen to the CDs. They have 28,000 displays in over 18,500 locations that now include mass merchants and specialty stores.
With business and Juno awards filling their shelves, Somerset Entertainment did various acquisitions and moved from $5M in revenues to $11M, until eventually they were achieving $21M in revenues. They bought a distributor and, in 1998, levered up with four flavours of debt: term debt, debt at 17% interest rate, revolving credit, and a vendor take back loan. Then the cracks began to show.
The Buffalo distribution fulfillment center had been shipping comfortably to over 100 different retail points when Andy asked, “Can you do higher volume?” Naturally, they answered, “Yes!” when in fact that was far from the truth. Somerset had been a company with $8M revenues and $2M in EBITDA (earnings before interest, tax, depreciation, and amortization—see glossary) but had grown into the supply chain approach with a distributor turning out to be slow and with the uncanny ability to mess up orders. They would say they had shipped goods—the display case with CDs—and Somerset would then invoice the retailer who, it turnrf out, had not received anything except a bill. It was October—prime pre-holiday selling time with the Christmas season around the corner.
Not good!
American retailers are the toughest sons of guns and were furious at being bamboozled. They told Andy they did not get the goods, but then told him not to bother coming around any more—they were through. Yikes! In one fell swoop, Somerset had gone from being swift deliverers of orders to slow, unreliable duds.
“We hit $36M in sales with $8.5M EBITDA but our debt was at $15M and for the first time, we stressed about breaking covenants. We got a valuation of $15M and, with reluctance, we decided to go with a private equity investment of $21M.”
In hindsight, Andy says getting private equity was good for the owners’ motivation. It took the edge off the worry about money and retirement. “With private equity buying part ownership, we were allowed to take a large chunk out for ourselves straight away but still retain control. I had been working very hard and it was good to get $6M out for the founder and owners.”
The money meant Somerset could pay off their debt straight away and still have $4M to make acquisitions.
Andy says, “With that extra cash, we set up an office in Chicago that has turned out to be the vital springboard into the American market, taking Somerset to the next level. We’ve had a bad year in there, but we did not have to worry about the business blowing up. The peace of mind meant we could focus on battening down the hatches to the storm and finding a new way forward.”
The private equity partners proved to be great sounding boards when Somerset was making acquisitions. The investors were more aggressive in wanting growth but respected Somerset’s decision to step away from some identified targets.
“Also, when we nearly lost a key person,” Andy adds, “The investors did bring him around and get him to stay.”
Andy adds, “When you are an entrepreneur working your butt off, it is great to get that cash pay out as well as have cash to grow the business. With private equity you get the best of both worlds—the cash liquidity without the rigorous scrutiny of the public market.”
“Not every company can go public,” says Andy. “Private equity will transition you.” See if you can go public. Take Andy’s test and put the necessary tick marks next to your chart.
− You are making enough money to pay for public listing and accounting.
− You are profitable.
− You have a strong growth curve for your revenues.
− You have a decent management team.
− You are a good size.
Andy says, “At the time of the private equity deal, we were too small to go public. With private equity investors, we got to retain control and we got liquidity. Private equity took us back from the brink with risky debt and looming covenants. They were the stepping stone to getting big enough until in 2005, Somerset did our initial public offering (IPO). Selling those secondary shares was sweet, too.”
As Andy Burgess stood on the stage and let the applause of the audience sweep over him, it struck him how far Somerset Entertainment had come and what a ride it had been so far.

This is an excerpt from Money Magnet: Attracting Investors to your Business. Read more: