The best of times, worst of times in equity capital

Journal Record, The (Oklahoma City), Jun 17, 2009 by Kirby Lee Davis

If merchant banker willingness to spend money is an indicator, the national recession may soon bottom out.

"People are just getting sick of sitting on the sidelines," said Marquez Bela, managing member of Covalent Capital LLC of Dallas.

He came to Tulsa's Oklahoma Aerospace Summit and Expo not just to present a Tuesday afternoon primer on liquidity alternatives, but to seek potential investments for his clients. While he expressed some concern over the wisdom of making deals at this time, he also showed optimism in identifying solid acquisition targets.

"What else are we going to do?" he said. "You can't just roll over. We'll either do these deals ourselves or, if you're looking for a growth deal, we'll take you to the market."

For the other side of the coin, aerospace executives needed to look no further than to Shawn Walsh, president of Imperial Private Equity of Dallas and pilot of the private plane Bela took to Tulsa. The Covalent client also came to Tulsa to give a presentation and seek deals, but Walsh did not voice equal optimism.

"I do think there are opportunities that can be had, but they're going to be difficult," he said.

The problem, Walsh said, revolves around lost capital. While he agreed that some investors still want to make deals - including his own firm - he said $510 billion in private equity capital was pulled off the table last year, up from $350 billion in 2007.

"That $510 billion represents about $1.2 trillion in buying power, when you add in debt leverage," he said.

Since much of it comes not just from the wealthy, but foundations, institutions, endowments and other large organizations - all still shaken by October's financial meltdown, augmented by fears of capital gains tax hikes under the Obama administration - he expects to see little if any to come back to market any time soon.

Some may have permanently evaporated with last year's 30-percent stock plunge, paralleling widespread asset devaluations.

Equity capital fundraising dropped 14.3 percent last year, he said, and more is expected this year. Leveraged buyout volume plunged from $434 billion in 2007 to $111 billion last year.

In some sectors, like the middle-market segment his company focuses on, Walsh agreed that deals to recapitalize or sell may still succeed. Such deals may often involve a 10-year partnership with a five-year investment period, the equity partners expecting a 20-percent upside after getting their money back but still leaving existing owners and managers with 35- to 45-percent ownership.

"They're really investing in the management team when they invest in a company," he said.

From capital markets, Walsh said deals for $20 million or less still fly fairly well. Above that it gets more difficult, with cash- flow lending almost nonexistent.

"The banks haven't come back around to syndicating deals," he said. "Because of that, leveraged buyout deals of more than $75 million are not getting done, and they're at a much higher interest rate."

That also reflects the end of the second-lien debt explosion, he said, which during the last five years inflated values while allowing more leverage.

Walsh said today's deals often reflect a 3.5-percent ratio of total debt to earnings before taxes, interest, and other factors.

Today's deals now require 42-percent equity down, he said, with the multiple of EBIDTA down from 8.3 percent to 6 percent or less.

But for businesses ready to break from the status quo and make such deals, firms like Imperial stand ready. Walsh said his family operation has $8 million to invest in companies with cash flow of $1 million to $5 million. Imperial hopes to make three to five such deals over the next few years. At an average of $2 million, he expects the firm could invest up to $20 million.

"For the good companies out there, there will be capital available," he said, seeing 2009 as a stabilization year.

While Covalent has come close, Bela said it has not managed to complete a transaction this year - and the clock's ticking. With the steps required to close a transaction, Bela said his firm would need a letter of intent in hand by the end of summer.

"We're very hopeful we'll get something done this year," he said, his firm focusing on deals from $1 million to $7 million in equity. "We've got a lot of firms we're talking to."