Henry R. Kravis is like a kid in a candy store. Three years into the worst bear market since 1929, the legendary dealmaker is buying companies left and right. Since June, his firm, Kohlberg Kravis Roberts & Co., has announced plans to acquire businesses worth about $7.5 billion. They include a Canadian phone directory publisher and a French electrical equipment maker. Besides, KKR is eyeing hundreds of American companies. "We're busy again. I love it," Kravis says.
The buyout kings are back. Not since the 1980s have the pickings been so rich for leveraged buyout firms like KKR in the high-profit, high-risk business of buying, fixing, and reselling companies. Sidelined throughout much of the late 1990s, when merger mania pushed asset prices out of sight, they are now picking up businesses at bargain prices as companies shed what they couldn't digest. Flush with more than $100 billion raised from the likes of pension funds, they're emerging as a powerful force in a new wave of restructuring.
This year, LBO deals have soared. Between January and Nov. 6, they were up 50% vs. the same period a year ago to $20 billion--three-fourths of that rise was in the third quarter when they accounted for almost 10% of all mergers and acquisitions announced. That's their largest share since 1989. By contrast, overall M&A activity shrank 57% to $379 billion.
Given their vastly increased financial clout, the LBO firms will be key players in refocusing companies on making better use of their capital instead of chasing growth at all costs. "LBO firms will play a substantially more important role in the current corporate transformation than they did in the 1980s," predicts Alan K. Jones, a managing director and co-head of the group that advises buyout funds at Morgan Stanley. "This is their renaissance."
It's not just low prices that are bringing buyout kings out of the woodwork. It's their conviction that they're in the sweet spot. They believe prices are not going to fall much further. At the same time, there's little risk that chastened companies will bid up prices. "With so many strategic buyers on the sidelines, the environment strongly favors financial buyers," says Sean O. Mahoney, a managing director at Goldman, Sachs & Co. who specializes in LBO financing.
Buyout firms are snapping up hot properties in industries with stable cash flow. Initially, they have focused on yellow-pages publishers, fast-food chains, and book publishers such as Boston's Houghton Mifflin Co. But they're expected to branch out across the economy, as distressed companies like Qwest Communications International (Q ), WorldCom, Vivendi Universal International (V ), and Nortel Networks (NT ) shed more assets.
In many respects what's happening is an about-face from the 1980s, when some buyout funds were the pariahs of the financial world--Barbarians at the Gate, as one book dubbed them. Back then, a handful of firms used mountains of debt to buy public companies in hotly contested deals, took them private, then ruthlessly cut costs to make them profitable.
This time around, LBO shops are invited guests. Sellers are thrilled to do deals with them. Managers consider the stock market more punishing than going private under a new owner. Many also see LBOs as their best chance to motivate managers whose options are under water. Once a company is taken private, buyout firms can shower managers with fresh options at dirt-cheap prices that they can cash in when the company is sold. "Our buyouts are management-led," says William E. Conway Jr., a co-founder of the 15-year-old Carlyle Group. "Hostile takeovers are a thing of the past."
But it's not going to be as easy for LBO firms to extract profits from their prizes. Their slash-and-burn methods are now standard management procedure, so there's less fat to cut. "Our job is a lot harder today because companies are better run," says Perry Golkin, a member of KKR. Adds Harold W. Bogle, a managing director at Credit Suisse First Boston: "You have to look to grow in more strategic ways."
That's why many buyout firms are rolling up their sleeves and getting involved in running the companies they buy. For example, Texas Pacific Group partners made sales calls on the top 15 customers of silicon wafer maker MEMC Electronic Materials Inc. (WFR ) to convince them the company was financially sound. "Firms will be substantially more hands-on than they historically have been," says James G. Coulter, a founding partner at Texas Pacific.
The pressure on firms to deliver returns may even spark another flurry of mergers--this time between the companies in buyout firms' portfolios. "You may see more financial buyers selling to financial buyers," says Carlyle's Conway. They may drive a hard bargain, though. In the mid-1990s, says Mark L. Sirower, head of the M&A practice of The Boston Consulting Group, corporate buyers on average lost 5% of what they paid for businesses, while LBO firms made roughly 25%. The superior returns show how closely major buyout funds scrutinize their deals. On average, they pick only one out of 100 they consider. "The difference is that corporations often acquire to be bigger. LBO firms acquire companies to make money," Sirower says.
Not that the LBO firms always get it right. Many are still nursing their wounds after straying from cheap, understandable businesses at the peak of the market. In 2000, LBO firms did $40 billion of deals after many lost patience waiting for the stock market to decline and took ill-fated gambles. Big firms--including Forstmann Little & Co. and Hicks, Muse, Tate & Furst Inc.--together lost billions of dollars on telecom investments made around that time. "I guess we could have all taken a year off and played golf, which would have been a great idea in hindsight," says Thomas O. Hicks, co-founder of Hicks Muse.
This bitter experience is making buyout firms a lot more cautious. Many are forming consortia to share the pain if deals go sour. On Oct. 31, four buyout shops--Thomas H. Lee Partners, the Blackstone Group, Bain Capital, and Apax Partners--said they teamed up to buy Houghton Mifflin from Vivendi.
This newfound caution sits well with today's LBO investors. More public pension funds are backing buyout firms than in the 1980s, and they face heightened scrutiny of their own investments. For example, the University of Texas Investment Management Co. (UTIMCO) recently decided to release its LBO returns on request--breaking a taboo for the secretive firms. "The board felt with the changes that had taken place in the overall environment, we would have to move to a higher level of disclosure," explains Bob Boldt, president of UTIMCO.
The less forgiving business climate presents other obstacles. For starters, bond investors to whom the LBO firms turn for debt financing are getting wary of big deals. And, because many of the companies for sale face shareholder lawsuits and investigations, it's becoming more complicated to close deals on schedule. For instance, the news on Nov. 4 that Vivendi's financial disclosures are under investigation by U.S. and French authorities could thwart the Houghton Mifflin deal. "I'm sure that is complicating the effort to close a sale," says Jonathan Newcomb, former CEO of Simon & Schuster Inc. and now a principal at private-equity firm Leeds Weld & Co.
For now, the buyout kings aren't too worried. They're giddy over the great American fire sale. Plenty more cheap merchandise will hit the racks. "We always thrive when there is turmoil in the markets, and God knows we have turmoil," says Kravis. When the going gets tough, the tough go shopping.
By Emily Thornton in New York, with Stephanie Anderson Forest in Dallas
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