Navigating through the fog

One of private equity's troubles is that sellers have yet to acknowledge falling prices. "We believe that the market is down 50% compared to 2007; the credit crunch and recession are equally to blame," says Ernst von Freyberg, managing director at Close Brothers. "On the one hand, private sellers now realise that they may get only two thirds of what they would have got a year ago - on the other hand, many of the assets they may want to buy with the money also cost only two thirds of what they used to, so the overall impact on the bottom line is not as severe as it may seem." But with prices down and many prospective buyers cautious, some private equity firms wonder whether this is indeed the time to acquire assets more cheaply than they have been for a long time.

Most vendors that decide to sell are in urgent need of cash. Hence, of those companies that become available, many are semi-distressed, distressed or in other special situation cases, which according to corporate financiers, saw an increase from around 20% to about half of all offers now on the table.

Private equity divestments have slowed significantly from the daily auctions seen during the boom; those that sell have received an offer they cannot resist or are making fire sales. "As a rule, if private equity vendors can get a money multiple of three, they are willing to sell," explains von Freyberg. If exit opportunities are few and far between, secondary and tertiary transactions have all but vanished.

To cope with the drought, many private equity firms are sourcing deals from the public markets, where prices are depressed and further under pressure due to a pervading sense of fear over a failure of the banking system and the wider economy. Pricing in the private sector orientates itself at the prices seen on the public markets. "If a listed company with a solid cashflow has a value of 2-4x EBITDA, the question is, how can private companies ask for much higher prices? In the current climate, getting 6-7x EBITDA is already quite an achievement," explains Dr Stephan Goetz, managing partner at goetzpartners. However, P2P deals are likely to remain rare, as major stakeholders of listed companies are unwilling to sell at low valuations.

With leverage no longer readily available, many buyout houses are looking at pure equity financings. BC Partners recently did this with the acquisition of SGB Starkstrom (see page 42), which was financed with almost pure equity and a vendor loan. "We have seen some all-equity deals but these are rare and people doing them are taking a view on their ability to releverage and the possibility of multiple arbitrage in the future," adds Richard Miller, director in the M&A practice of PricewaterhouseCoopers. However, this ability may not be widespread. "For us, it remains dubious whether the debt markets will have thawed sufficiently to allow those transactions to be refinanced - and almost certainly not at the conditions enjoyed at the height of the boom," Dr Goetz warns.

The once widely-used auction is now being replaced by one-to-one transactions and proprietary deals, which are more likely to close, but at the same time rely more on expertise, sector knowledge, contacts and network. A contributing factor is that a fifth to a third of deal processes are not finalised, and the overall process is dragged out considerably due to all parties' in-depth due diligence that has replaced the rushed-through deals seen during the boom. "Much insecurity is also caused by strategic investors, who, in these opaque times, can see their own value plummet by 40% and cannot justify acquisitions to the stakeholders. For private equity, the main risk is that the banks pull out of the financing before the deal is signed," explains von Freyberg.

Responding to the new paradigm

All these changes have affected the relationship between private equity firms and their advisers. "At present, we are helping buyers and sellers to understand what is possible in this market; there is a real need to explain and explore all the available options and to work a way around any issues," adds Richard Miller. GPs agree with this sentiment: "Probably the core change in the relationship is that the topic of financing has moved to the forefront, especially how to secure debt, how to structure the financing with new acquisitions, and also how to refinance existing portfolio companies," states Peter Hammermann, co-head of Barclays Private Equity.

Faced with these challenges for their clients and their own business, corporate financiers have responded in a number of ways to adapt to the changed climate. "We at Close Brothers are at last year's level in terms of mandates and closings, which is astonishing, but we see more mandates being put on hold as the economic performance of businesses deteriorates. However, we have just expanded into Switzerland, where we opened an office in Zurich and our debt advisory and restructuring business has grown to 10 people," says von Freyberg.

Corporate financiers agree that expanding their sector and industry know-how is crucial, as is the need to ramp up capabilities to respond to the needs of their clients. "We have just created a completely new joint venture with LBBW, which brings us much closer to the debt providers. The bankers now sit at the same table when we work on a debt structure," says Dr Goetz. "The timing for this is excellent given how the market has deteriorated and the needs of clients have changed." goetzpartners has established a restructuring team, complete with interim management capabilities to provide new integrated services to clients, or to serve as a platform to bring the different teams together.

This flexibility is likely to be sorely needed; debt remains scarce. "In the past we spoke about cov-lite deals. Now we're seeing leverage-lite," Richard Miller sums up. "Financing packages are available in the market and we're doing deals across Europe, however these packages are agreed on a case-by-case basis and using the skills we have in our pan-European debt advisory team is now more important than ever."

Now that Germany has officially entered the long-anticipated recession, the outlook is unlikely to brighten anytime soon. "The question is not whether 2009 will be difficult - but how difficult," adds Ernst von Freyberg. One source compared the situation that the industry finds itself in to that of a skier suddenly surprised by thick fog - in such a situation, everybody is moving very carefully and very slowly.

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