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Private equity deal activity remains slow, report finds

Although US private equity mergers and acquisitions activity is still quiet, private equity firms continue to look for opportunities to invest, according to a report by Ernst & Youn

Although US private equity mergers and acquisitions activity is still quiet, private equity firms continue to look for opportunities to invest, according to a report by Ernst & Young.

The report says PE participation in minority stake deals is returning after taking a back seat in 2005 through 2007, a period during when mega-deals were in full swing. In addition, government reform in healthcare and financial services may present investment opportunities.

"PE firms are sitting on a large amount of available cash. However, leverage is still almost non-existent which is hampering deal flow and cash deployment," says Gregg Slager, Americas private equity leader at Ernst & Young.

Announced US PE deal volume fell 42 per cent in 2008 compared to 2007. This downward trend has continued into 2009 with 314 transactions announced through May of this year, the lowest five-month volume since 2002.

"The bid-ask spread – the price buyers are willing to pay and the price sellers are willing to sell – hasn’t narrowed. Until it does, activity will be slow," Slager says.

According to Ernst & Young’s 2009 US PE report, although PE firms have historically experienced the best returns from investments made during a down market, PE will be slow in returning to the M&A arena until the credit and capital markets recover.

In late 2008 through early 2009, several high profile PE portfolio companies have exchanged or repurchased their debt. This trend is likely to continue through 2009 and 2010 as some USD370bn in high yield and institutional debt is due between 2010 and 2011, according to Thomson Reuters LPC’s 1Q09 US Loan Market Review.

On a year-over-year basis, PE US minority transactions dipped by 165 deals to 212 transactions in 2007 and then increased to 273 in 2008. For the first five months of 2009, PE firms announced 153 minority stake transactions in US businesses, 12 more than the same period last year.

Private investment in public equity (Pipe) transactions also gained popularity in the wake of liquidity absence, according to the Ernst & Young report. The dollar value of US Pipe transactions by PE increased more than fivefold in 2008, from USD3.4bn in 2007 to USD19.1bn, and the PE share of the US Pipe market rose from four per cent in 2007 to 11 per cent in 2008, according to Sagient Research System’s PlacementTracker. That said, Coller Capital’s summer 2009 Global Private Equity Barometer report, which surveys 120 global private equity investors, indicates that two-thirds of limited partners surveyed were unhappy with general partners making Pipe transactions.

The report says technology, consumer discretionaries, life science and energy will be among the more active sectors as the economy recovers. Additionally, recently proposed healthcare and financial services reforms by the Obama Administration may present investment opportunities.

The push for healthcare reform will create opportunities across the healthcare spectrum as the President’s healthcare reform agenda includes providing universal healthcare coverage, improving the quality of care and constraining the growth in healthcare spending. Healthcare sectors ranging from managed care to hospitals and long-term care to life sciences could be significantly affected by healthcare reform legislation.

Meanwhile, the attempts and programs introduced by the Administration to revive the banking sector will likely draw continued interest. In addition, there is a great need for capital in the banking system, and PE is evaluating a large number of opportunities in the market, albeit mostly as co-investors with other PE firms.

"Most existing regulations prevent a single PE firm from gaining control of a bank, which generally makes it less attractive to these investors," says Nadine Mirchandani, an Ernst & Young transaction advisory services partner.

The larger bank deals to date, which include IndyMac and BankUnited, have been club deals with several PE firms.

"The rules may be in flux as various bank regulators come down on opposite sides of the issue and the Treasury continues its courtship of private capital to purchase bank assets," Mirchandani says.

The report finds PE firms will face fund-raising challenges over the near term as limited partners rebalance investment portfolios and secondary interest funds offer investors alternatives to new funds. PE-related M&A activity will likely continue at low levels for the second half of 2009. Despite lower levels of M&A activity, PE firms are still busy and are focused on deriving value from the portfolio companies, many of which have faced capital challenges and constraints.

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