In the 1980s, the role of fire-starter was played by leveraged-buyout firms, which made deal after deal, each one bigger than the last. Fueled by junk bonds, their free-spending ways helped the stock market soar. Even after the LBO craze ended with a wave of defaults and indictments, the stock market kept virtually all of its gains.
Similarly, today's cash-rich buyout funds and private corporations are showing themselves willing to pay handsomely for control of entire public companies. This influx of money could set the stage for a broad upsurge in the stock market, especially since the takeovers are helping to shrink the supply of public securities available for other investors.
HALFWAY POINT. The latest play: Koch Industries, the giant family-run company that agreed on Nov. 13 to pay a hefty premium of 39% over the pre-deal price to acquire Atlanta-based papermaker Georgia-Pacific (GP
). Coming down the pike is a likely buyout of Computer Sciences (CSC
) by Lockheed Martin (LMT
) and three private firms, and Knight-Ridder's (KRI
) possible takeover by private-equity firms after the newspaper chain put itself up for sale on Nov. 14. On Nov. 16, conglomerate Tyco International (TYC
) announced it might sell itself off in pieces to unlock shareholder value.
There's plenty more to come. Buyout funds raised money at a $68 billion annual rate through September, compared with $46 billion in 2004, according to Thomson Venture Economics and the National Venture Capital Assn. Blackstone Group is raising a $12.5 billion megafund, Thomas H. Lee Partners a $7.5 billion fund, and Madison Dearborn Partners a $5 billion fund, to name three.
"We are probably in the middle" of the buyout cycle, says Steven N. Kaplan, a University of Chicago economist. He calculates that fund-raising by nonventure partnerships -- including buyout funds -- now adds up to more than 0.5% of stock market capitalization. That may not sound like a lot, but it's getting close to the peak of the '80s frenzy.
MOUNTING EXCITEMENT. It's not simply that private buyers are paying up to get full control of companies. Purchases also have a halo effect on other players in the same industry. Eddie Lampert's purchase of Sears, Roebuck & Co. stimulated interest in department stores. Now, Koch's purchase of Georgia-Pacific has helped bump up the stock prices of International Paper (IP
) and Weyerhaeuser (WY
"Something about a private firm buying a publicly traded company gets everybody excited, wondering if they know something we don't know," says Edward Yardeni, chief investment strategist of Oak Associates, an Akron money manager.
For an inkling of the impact of buyouts so far, take a look at how fast shares are disappearing from the public markets. In the first half of 2005, the combination of buyouts, stock buybacks, and other deals gobbled up $260 billion of nonfinancial corporate equity at annual rates. This flow of money buying up stock is only a little less than a more familiar source of stock purchases -- the $288 billion annual rate of household investment in mutual funds in the first half of the year.
LAYING A FLOOR. Not everyone thinks private buyout action is powerful enough to lift the entire stock market. Stefan Selig, vice-chairman for global investment banking at Banc of America Securities, says the impact is being felt mainly in sectors with many "LBO-able" companies -- ones with steady cash flows and low price-earnings multiples.
But even if buyout funds don't buoy all stocks, they can put a floor under prices through their willingness to snatch up undervalued companies. That wouldn't be as good as a stock market boom, of course, but it might help ordinary investors sleep better.
Coy is BusinessWeek's Economics editor in New York