Private equity deal activity remains slow as pricing equilibrium between buyer and seller has yet to be achieved - Ernst & Young - United States

Private equity deal activity remains slow as pricing equilibrium between buyer and seller has yet to be achieved

New York, 23 July 2009 — 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, Americas 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).

“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.

In late 2008 through early 2009, several high profile PE portfolio companies have exchanged or repurchased their debt (see chart). This trend is likely to continue through 2009 and 2010 as some $370 billion in high yield and institutional debt is due between 2010 and 2011 according to Thomson Reuters LPC’s 1Q09 US Loan Market Review.

On a year-over-year basis, PE U.S. minority transactions dipped by 165 deals to 212 transactions in 2007 and then increased to 273 in 2008. For the first five months of 2009, PE firms announced 153 minority stake transactions in U.S. businesses, 12 more than the same period last year. We are likely to see this trend continue for the remainder of the year.

Private investment in public equity (PIPE) transactions also gained popularity in the wake of liquidity absence, according to the Ernst & Young report. The dollar value of U.S. PIPE transactions by PE increased more than fivefold in 2008, from $3.4 billion in 2007 to $19.1 billion, and the PE share of the U.S. PIPE market rose from 4% in 2007 to 11% in 2008, according to Sagient Research System’s PlacementTracker. That said, Coller Capital’s summer 2009 Global Private Equity Barometer report, which surveys 120 global private equity investors (limited partners), indicates that two-thirds of limited partners surveyed are not enthusiastic about general partners making PIPE transactions.

It’s expected technology, consumer discretionaries, life science and energy will be among the more active sectors as the economy recovers. Additionally, recently proposed healthcare and financial services reforms by the Obama Administration may present investment opportunities.

• Healthcare reform—the push for healthcare reform will create opportunities across the healthcare spectrum as the President's healthcare reform agenda includes providing universal healthcare coverage, improving the quality of care and constraining the growth in healthcare spending. Healthcare sectors ranging from managed care to hospitals and long-term care to life sciences could be significantly affected by healthcare reform legislation.
• Financial services—the attempts and programs introduced by the Administration to revive the banking sector will likely draw continued interest. In addition, there is a great need for capital in the banking system, and PE is evaluating a large number of opportunities in the market, albeit mostly as co-investors with other PE firms.

“Most existing regulations prevent a single PE firm from gaining control of a bank, which generally makes it less attractive to these investors,” said Nadine Mirchandani, an Ernst & Young LLP Transaction Advisory Services partner who specializes in financial services. The larger bank deals to date, which include IndyMac and BankUnited, have been club deals with several PE firms. “The rules may be in flux as various bank regulators come down on opposite sides of the issue and the Treasury continues its courtship of private capital to purchase bank assets,” Mirchandani stated.

The report finds PE firms will face fund-raising challenges over the near term as limited partners rebalance investment portfolios and secondary interest funds offer investors alternatives to new funds. PE-related M&A activity will likely continue at low levels for the second half of 2009. Despite lower levels of M&A activity, PE firms are still busy and are focused on deriving value from the portfolio companies, many of which have faced capital challenges and constraints.

About Ernst & Young Private Equity
Value creation goes beyond the investment cycle to portfolio company management and fund support. Deal success doesn’t end when the deal closes. Savvy acquirers know success and stakeholder value lie in portfolio companies’ continued growth under their watch and after their exits. Portfolio companies continually face operational, growth, regulatory, industry and market challenges and each challenge needs to be assessed to achieve sustainable growth. Therefore, private equity firms cannot be adequately served by supporting their M&A activity alone.

Ernst & Young’s Private Equity practice offers a holistic, tailored approach that encompasses the needs of funds, their M&A process and portfolio companies while addressing market, industry and regulatory concerns and opportunities. With a global network of over 8,000 dedicated M&A professionals and more than 20 years of private equity experience, we can meet private equity firms’ and their portfolio companies’ evolving needs.

For more information, visit our website at www.ey.com/us/privateequity.

About Ernst & Young
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This news release has been issued by Ernst & Young LLP, a member firm of Ernst & Young Global Limited.

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