LBO Comeback Nears as PetSmart Leads Busy Two Months: Real M&A

By Alex Sherman, Brooke Sutherland and Tara Lachapelle

Leveraged buyouts may be back in vogue.
In a year when merger activity was dominated by companies combining with one another, private-equity deals have started to make a small comeback. The 12 LBOs announced since the start of November -- from PetSmart Inc. (PETM) to Riverbed Technology Inc. (RVBD) -- marked the busiest two-month period for such transactions since 2010, according to data compiled by Bloomberg.
Financial buyers are showing a renewed interest in publicly traded companies such as PetSmart, which drew bids from at least three buyout firms. The pet-supplies chain had the characteristics they look for: A cheap stock, low leverage and room for operational improvement.
The pickup in LBOs will probably continue into 2015, though it’s unlikely to break any records. Buyout firms still have to contend with stock prices near all-time
highs and an increasingly jittery junk-bond market, and they’re largely restricted from attempting the megadeals they’ve been known for.
“Lots of buyout firms raised capital over the past two years,” said David Fann, chief executive officer of TorreyCove Capital Partners, which advises investors in private equity. The firms “are eager to put money to work, but also trying to stay disciplined.”
While activity has picked up, it’s still nowhere near the boom levels of 2006 and 2007, when private-equity firms joined together to make huge bets on companies. That time was marked by transactions such as the record $45 billion buyout of TXU Corp. by Kohlberg Kravis Roberts & Co. and Texas Pacific Group.

Corporate Competition

Since 2007, when global private-equity-led deals accounted for $589 billion, there hasn’t been a year when volume has topped $150 billion, data compiled by Bloomberg show. Activity has been restrained by soaring equity valuations and greater competition from strategic buyers, who are typically able to offer more for a target because of the cost and revenue benefits that come from combining two like businesses.
“In general we see corporates being a bit more active,” said Marco De Benedetti, managing director and co-head of Europe buyouts group at Carlyle Group. “The explanation I have for that is today if you’re the CEO of a large European business, it doesn’t matter what sector you’re in, you’re likely to have an issue of growth, have a good balance sheet and have access to cheap credit. Those are pretty good ingredients to do M&A.”

Smaller Deals

Private-equity firms also just aren’t tackling the big targets. Of the 64 public companies that announced buyouts by financial firms, 75 percent of those deals were worth less than $1 billion, data compiled by Bloomberg show. Even so, November and December saw more LBOs worth over $100 million than any two-month period since 2010.
“The pace of activity has been very, very strong -- not so much in terms of the bigger deals,” Mel Cherney, a partner at law firm Kaye Scholer in New York who has represented private-equity buyers, said in a phone interview. The dynamics are the same -- a record amount of dry powder and debt financing that’s still available for the time being -- but “anything that’s bigger obviously just requires more money.”
Club deals, where firms team up to pursue a target, have largely disappeared amid government scrutiny. That may continue to curtail large transactions.

Likely Targets

Private-equity firms may instead home in on smaller takeover candidates, particularly in industries such as retail, where there are a number of corporations with cheap valuations and ample cash flow. Energy explorers, battered by the slump in oil prices, could also ripen as targets. Companies with enterprise values of less than $6 billion are in the “sweet spot” for buyout candidates, said Fann of TorreyCove.
Abercrombie & Fitch Co. (ANF) and Big Lots Inc. (BIG) are some of the most attractive prospects, said Joshua Schachter, a money manager at Sewickley, Pennsylvania-based Snow Capital Management. His firm manages about $4.4 billion and owns shares of both companies.
Those retailers are trading at a discount to their peer groups, generate good cash flow, have little debt and are set to benefit from a drop in gas prices as consumers funnel extra dollars toward shopping, Schachter said. Abercrombie, a $1.9 billion chain, is also in the midst of a management shakeup that may provide an entry for a buyer. Big Lots has a market capitalization of $2.1 billion.
“Much more will happen in 2015 -- it’s not a blip in the radar,” said Peter Lehrman, CEO of Axial Networks Inc., an online network for professionals buying and selling private companies.