Middle still has buyout room
The economy is soft and the credit markets are tight, but that hasn’t stopped Triton Pacific Capital Partners from making deals.
The Century City-based private equity firm is completing the purchase of two companies and is on the prowl for other acquisitions.
“We’re able to go and continue to find very attractive investment opportunities even in a constrained financing environment,” said Craig Faggen, Triton’s managing partner.
At a time when the biggest players in the private equity industry are suffering through a bruising downturn, smaller firms such as Triton Pacific that invest in mid-size -- or “middle market” -- companies have emerged as a rare bright spot.
These firms have been able to keep investing -- albeit at a reduced pace -- even as mega firms have been all but sidelined by the credit crunch. And the portfolios built up by middle-market firms during the buyout boom that ended last year are less likely to contain companies acquired at excessive prices with extreme levels of debt.
Unlike giant private equity firms such as Blackstone Group and Kohlberg Kravis Roberts & Co. that typically buy publicly traded companies they view as undervalued, hoping to sell them at higher prices within a few years, buyout firms focusing on the middle market tend to look for growing private businesses that need capital for further expansion and can benefit from the buyers’ operational and management acumen.
The fortunes of this more-modest segment of the private equity business are particularly important in Southern California, which has few large private equity firms but is dotted with scores of smaller ones focused on the middle market.
These middle-market investors certainly aren’t immune to the larger forces buffeting the private equity business. After enjoying years of free-flowing credit that amped up investment returns, they too are having more difficulty financing transactions as loss-ridden, capital-starved banks rein in lending.
The difference is that while major banks have pulled back almost entirely from billion-dollar buyouts, smaller lenders still are bankrolling less-expensive middle-market transactions.
The smaller lenders “still seem fairly willing to do loans,” said Ed Villeneuve, managing director in the Los Angeles office of investment bank Lazard Middle Market.
And some mid-size companies are being acquired mostly or entirely without debt.
The upshot: fewer deals, but not a total shutdown.
The 91 middle-market firms that researcher GF Data Resources tracks bought 37 companies in the first six months of this year. That’s down from 48 in the second half of last year and 65 in the first half of 2007.
Meanwhile, private equity buyouts exceeding $500 million tumbled to 15 in the second half of 2007 from 52 in the first half, according to Thomson Reuters. There were 13 such acquisitions in the first six months of this year, the company said.
Within that group, blockbuster deals topping $5 billion have shriveled the most. Since the 13 in the first half of last year and two in the second half (both of them in the third quarter), there have been none, according to Thomson Reuters.
“While deal volume and values clearly have stepped back in the middle market, the overall environment is relatively calm and functional compared to the roiled waters of the larger private equity world,” said Andy Greenberg, chief executive of GF Data Resources in West Conshohocken, Pa.
As they manage to keep doing deals, middle-market firms may suffer less than their larger brethren from losses on acquisitions they made during the good times.
One reason is that middle-market firms typically didn’t load up their portfolio companies with as much debt.
“They never relied on financial engineering per se as the sole basis of generating return,” said Todd Moody, a private equity expert at Ernst & Young.
Another reason is that prices never climbed as high in the middle market. Whereas mega firms typically bought public companies whose stock prices had soared during the recent bull market, middle-market firms specialized in more reasonably priced private concerns.
“They paid up, but generally not as much as the bigger firms,” said Dan Primack, editor in chief of Thomson Reuters website Private Equity Hub.
Nonetheless, the weak economy is chipping away at the performance of middle-market portfolio companies. How those portfolios perform will depend in part on whether fund managers can boost the operating performance of their companies in a challenging environment.
Dan Lubeck, founder of Solis Capital Partners in Newport Beach, predicts that buyout boom excesses will catch up with “a bunch” of middle-market firms already “struggling with portfolios of underperforming, over-leveraged companies.”
“There will be a weeding-out,” he said.