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THE ASHES
Thomas More Griffin Gibbons P.C. One Penn Plaza--37th Floor New York, New York 10119-3701 Direct: (212) 613-2031 Fax: (212) 554-9603 (tgriffin@gibbonslaw.com)
Thomas More Griffin is a Director in the Corporate Department in the New York Office of Gibbons P.C., a regional law firm with offices in Newark, Trenton, Philadelphia and New York City. He focuses his practice on private equity funds, business development companies, hedge funds, private placements, SEC regulations, including Investment Company Act and Investment Advisers Act regulations, and mergers and acquisitions. The views expressed in this article are those of Mr. Griffin and not of his firm, Gibbons. This article was written in March 2010.
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Introduction The Greatest Recession which commenced in 2007, picked up steam in 2008, ran into high gear in 2009, and is still lingering in 2010, has had a material adverse effect (MAE) on private equity and leveraged buy-outs (LBOs). During this period, private equity and mergers and acquisitions have had to withstand a trying twelve-round boxing match akin to the AliFrazier Thrilla in Manila fight against the likes of panic in the markets, frozen credit markets worldwide, substantially reduced fundraising, deal inertia and flight, difficulty in exiting investments, deteriorating global stock markets, and severe slowdowns in the debt, equity and initial public offering (IPO) marketplaces. The year 2009 was one of the worst years in the history of private equity and LBOs. For example, in the fourth quarter of 2009, fundraising for private equity funds was at its worst since 2004. Although mergers and acquisitions transactions were somewhat better in this quarterly period, we are witnessing a strange transformation in the private equity and LBO marketplace. The days of the prowess of the mega funds (multi-billion dollar funds) and easy acquisition debt have moved to the immediate sidelines and the small cap and mid cap private equity funds have taken center stage. There is an underlying belief in the marketplace that we will not soon cycle back to the days of years like 2006 and 2007 when mega funds and deal mania were kings. The banks are now very cautious in lending into LBOs and the equity going into deals is in the forty percent (40%) range. Given what has happened during the Greatest Recession, we may think we are doing private equity and LBO transactions reciting the jabberwocky poetry of Lewis Carroll's Alice In Wonderland. Has the Greatest Recession caused third degree burns to private equity and LBOs that will not heal? Is the landscape too charred for regrowth? The answer to these two questions is no. Private equity and LBOs have battled the Greatest Recession, come out a little beat up, but have healed and are in the midst of a cautious comeback.
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Prelude to a Collapse and the Greatest Recession Gains Strength: Private Equity and LBOs Falter In June 2007 two Bear Stearns hedge funds -- High-Grade Structured Credit Strategies Enhanced Leverage Fund and the High Grade Structured Credit Strategies Fund -- which had been set up ten months earlier and mainly invested in subprime mortgages, collapsed and their assets were seized by Merrill Lynch. This was the start of the public collapse of the mortgagebacked securities market, although the mortgage-backed market had experienced losses in 2006. Subsequently, Bear Stearns collapsed and was sold in a fire sale in March 2008 to JPMorgan Chase. On September 15, 2008, Lehman Brothers filed for Chapter 11 bankruptcy protection (after selling only certain assets to Barclays) and during this month American International Group (AIG) was bailed out by the U.S. Government with an $85 billion credit facility. Many of the large U.S. commercial banks -- such as Citibank, Bank of America, Key Corp, Capital One and numerous others -- experienced severe balance sheet problems as a result of the mortgage-backed crisis and worldwide credit crisis and sought and obtained U.S. government assistance. A global credit and banking crisis was taking place at banks around the world. Some feared that we had entered the Second Great Depression, but a severe recession was gripping the world as professionals and market participants fretted as to what would happen to private equity and LBOs. All of the above factors had a profound negative effect on the private equity industry and LBOs. The years 2006 and 2007 and a good deal of 2008 had been very robust for private equity, mergers and acquisitions and LBOs -- this period represented one of the best times in the industry. But this would change dramatically.
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The calamity in the markets was accompanied by the Greatest Recession. This had severe repercussions around the world, especially in the United States. The stock market during 2008 and 2009 witnessed massive losses; during 2009, for example, the Dow Jones Industrial Average (DJIA) started the year at 9,034, dipped to 6,547 on March 9, 2009 and moved up to 10,428 on December 31, 2009. Unemployment in the United States during 2009 moved into the high nine percent range. The beneficial conditions for private equity and LBOs deteriorated rapidly in 2008 and 2009. High leverage multiples and covenant lite loans were few and far between. Higher equity requirements and more stringent lending terms and debt covenants were now in force. Fundraising and deals slowed to a crawl. Against the backdrop of these events private equity could not continue at the same pace. 2009 would represent a distressing turning point for private equity and LBOs. Deal volume and private equity fundraising collapsed; a great number of private equity funds closed. The weight of the recession, global credit crisis and stock market collapse, investors seeking safer asset classes and decline in the values of funds' portfolios, were too much for the industry to hold up against. The value for private equity deals in 2009 was $77 billion, a 61% reduction from 2008 ($190 billion), and 88% down from 2007 ($659 billion). The number of LBO deals has also declined: 2009 - 925; 2008 - 1,846, and 2007 - 2,556. Source: Preqin. LBO Activity The chart below shows the amount of capital called up by private equity firms and total deal volume by year from 2003 - 2009 (first half). Note the substantial decline in activity during 2008 and the first half of 2009:
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Annual Global Buyout Firm Capital Called Up and Global Buyout Deal Volume
800
700
685 659
600
500
Capital Called Up by Buyout Funds ($bn)
400
295
190
100
The next chart shows the number and value of deals by year from 2000 to 2009. Note the buyout strength during the years 2005, 2006 and 2007, followed by a significant decline for the years 2008 and 2009.
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2547 2500
2556
1500
1363
1334
No. of Deals
962 685.1
925 658.9
245.6 102.3 0 2000 2001 2002 2003 2004 66.4 111.1 143.6
Source: Dealogic/Preqin
The charts below show announced United States private equity deal volume and announced United States private equity deal value from 2000 to 2009 (first quarter). Again, the decline in 2008 and 2009, particularly in deal value, is substantial.
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1600
1,622 1,527
1200
782
565 1,072
643 879 816 800 680 584 481 371 400 302 694 536 335 0 2000 2001 2002 2003 2004 2005 2006 2007 2008
Source Dealogic This chart captures transactions where the buyer is a US or foreign private equity firm acquiring a US based target
622
436
282
309
412
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$300
$200 $152.3
$191.8
$100 $80.0 $63.8 $36.9 $0 2000 2001 2002 2003 2004 2005 2006 2007 2008
Source: Dealogic This chart captures transactions where the buyer is a US or foreign private equity firm acquiring US-based targets
$66.4
$77.4
$5.5 1Q 2009
The chart below shows for the years 1998 to 2009 all announced merger and acquisition activity broken into two categories: (a) strategic mergers and acquisitions; and (b) buyouts. Note the 2008 and 2009 declines.
Announced U.S. M&A activity Strategic M&A $(bn) # 1998 1,428.67 10,623 1999 1,447.09 9,812 2000 1,414.87 9,437 2001 723.70 7,369 2002 383.55 6,505 2003 459.83 6,269 2004 651.28 6,727 2005 913.38 6,510 2006 1,027.46 8,224 2007 1,022.51 8,642 2008 872.21 7,286 2009 YTD 417.26 3,939 Sources: Dealogic LBO $(bn) 33.93 58.81 43.89 18.91 48.57 56.33 109.03 132.06 397.01 377.15 61.82 14.47
# 278 461 524 257 377 444 616 843 1,088 1,020 710 341
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This chart illustrates that United States LBO activity declined from $377 billion (value) in 2007 to $62 billion (value) in 2008 and $14 million (value) in the first nine months of 2009. These declines are staggering when you examine how far United States LBO activity fell in 2008 and 2009 from the high levels in 2006 and 2007. One is reminded of the fall off in LBO activity in 2001 and 2002 after the dot-com bust of 2000-2001 although this decline was not as severe. The strategic mergers and acquisitions and LBO markets rebounded a few years after the dot-com bust, but it was a slow recovery. Private Equity Fundraising The Greatest Recession has wreaked havoc on private equity fundraising. During 2009 private equity fundraising experienced severe declines. The chart below shows quarterly global private equity fundraising from the first quarter of 2003 to the fourth quarter of 2009. Note the fourth quarter of 2009 when only $35 billion was raised. You have to go back to the third quarter of 2003 to find a lower number ($18 billion). Also note the high in the second quarter of 2007 when $212 billion was raised.
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Quarterly Global PE Fundraising, Q1 2003 - Q4 2009 250 212 Aggregate Capital Raised ($bn) 200 149 150 107 100 55 52 48 50 63 95 80 37 22 20 18 0
20 05 20 06 20 04 20 05 20 07 20 07 20 08 20 03 20 03 20 06 20 04 20 09 20 09 Q 3
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118
50
20 08 3 Q Q
Source: Preqin
The chart below shows global private equity fundraising by number of funds closed and funds raised for 2004 to 2009 (first quarter). Note the dramatic fall off for 2009.
600 # of funds closed Funds raised 500 494 499 $452.4 $448.7 399 400 $379.9 409
2005
2006
2007
2008
1Q 2009
The chart below shows total United States buyout and mezzanine fundraising for 1997 to 2009 (first six months). Again, the decline in 2009 is apparent.
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Figure 12 U.S. buyout and mezzanine fundraising ($M) Mezzanine funds Buyout funds 229,770.9
300,833.7 264,137.9
165,786.9
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009 YTD
Secondary funds raising equity capital also suffered during the Greatest Recession. See the chart below.
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4.1 3.5
2.6
2.2
2.1
0.8
0.8
0.4 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
1995
1996
2010: Rebound, Change and Cautious Optimism in Private Equity and LBOs The outlook for 2010 for private equity and LBOs looks promising but should be characterized as cautious optimism. The level of private equity fundraising commitments are improving. Investors have indicated that they will allocate more funds to private equity. Smaller and mid-size private equity funds remain in the spotlight, although this could change as mega deals are picking back up which need mega funds. Mergers and acquisitions activity is also picking up along a broad range of transactions, but not back to any prior frothy levels. The fundraising activities of private equity funds is intense. Investors are interested, but cautious. The chart below shows this. Note twenty-five percent (25%) of respondents being "unsure at present" with respect to their next commitment to a private equity fund.
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Time Frame of Next Intended Commitment to a Private Equity Fund 60 Proportion of Respondents (%) 51% 50 40 30 20 10 0 H1 2010 H2 2010 2011 Unsure at Present Not Investing for at Least Tw o Years Source: Preqin 15% 4% 4% 25%
Investors pondering going into private equity funds are concerned with exit opportunities. This issue is illustrated in the graph below.
339
300
253 185
200
175
79 104 123
100
154 50 37 25 28 15 13 34 16 29 75 112 52 121 102 19 5 14
12
2000
2001
2002
2003
2004
2005
2006
2007
2008
1Q 2009
Source: Dealogic This chart captures sell side transaction where the seller is a US-based private equity firm and the acquirer can be a domestic or foreign PE firm or a corporation
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Also, as the chart below indicates, exit by IPO has been very difficult in the past two years but will undoubtedly improve in 2010:
U.S. financial sponsor-backed IPOs ($B)
100 25
Number of deals
40
10
20 $2.52 $1.74
0 2005
Year to date: 1/09 - 9/09 Source: Dealogic
The highlights for 2010 for private equity and LBOs are: Investors gradually returning to market. Amount of capital and number of
investors will increase over historically low 2009 levels. Investors most interested in distressed private equity funds in the small and midsize level. Belief that investments made by these funds during stages of recession could bring healthy returns. Private equity fund terms are changing and becoming more friendly to investors. Investors usually will not invest in a fund if they do not like the fund's terms and
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Value in billions
60
15
conditions. Frequent areas of negotiation and change are management fees, carry structure, clawback, rebates and compensation. Investors are conducting more due diligence, and scrutinizing transactions, portfolios and the history of the fund. Estimates are that private equity funds have $500 billion in deployable capital or "dry powder." Mergers and acquisitions deal flow is picking up in the first quarter of 2010, although the banks are extremely cautious in lending into a transaction and are demanding high equity requirements (can be in the forty percent (40%) range). This is a problem faced globally. The recent banking, currency and fiscal crises in Greece, Spain and Portugal do not help. Fund managers are facing difficulty restructuring financing for existing portfolio investments. Sellers again seem interested in selling and closing. Pace of private equity backed IPOs should increase. Leveraged distributions will stay very quiet. The Greatest Recession dealt a powerful blow to private equity, LBOs and mergers and acquisition transactions. But this business is very cyclical and seems poised for a healthy rebound in 2010. The phoenix is rising from the ashes. Recent Private Equity and LBO Transactions Recently, Southpaw Credit Opportunity Fund FTE Ltd. raised $570 million from 92 investors putting up a minimum of $5 million each. Southpaw is based in Greenwich,
Connecticut and is an event driven private equity fund focused on deep-value distressed and special situation opportunities. And Solar Capital Ltd., a business development company headed
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by a former Apollo founder, recently raised $200 million to purchase leveraged and mezzanine loans. Fundraising by smaller and middle sized private equity funds has been strong. Listed below are examples of recent LBO/merger and acquisition transactions. DATE 3/2/2010 3/3/2010 3/3/2010 2/3/2010 2/11/2010 2/25/2010 2/12/2010 2/16/2010 2/2010 TRANSACTION Prudential PLC acquisition of AIG Asian life insurance business for $35.5 billion. Hedge fund Elliott Associates LP bids $1.8 billion for Novell Inc. Dow Chemical to sell Styron plastics business to private equity fund Bain Capital Partners for $1.63 billion. Private equity fund Platinum Equity of Beverly Hills buys Wood Manufacturing/Genmar holdings, $1.1 billon in sales. Affiliated Managers Group Inc. acquires Pantheon Ventures, London private equity fund of funds, for $775 million. SkillSoft of Dublin (UK) $1.1 billion - sale to Berkshire Partners, Advent, Bain Capital - in going private transaction. Oak Hill sells Duane Reade to Walgreen $1.1 billion. Express retail chain $200 million IPO, owned by Golden Gate Private Equity Inc. Simon Property Group $10 billion all cash bid for General Growth Properties.
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"Know Your SEC Reporting Positions: SEC Gives Interpretive Advice and Guidance on Sections 13(D) and 13(G) of the Securities Exchange Act of 1934, as Amended," Corporate & Finance Alert, November 3, 2009 "Business Development Companies Selling Shares in Public Offerings to Raise Money to Invest In and Acquire Distressed Middle Market Companies," Corporate & Finance Alert, September 8, 2009 "SEC Proposes Rule Amendments to Facilitate Rights of Shareholders to Nominate Directors," Corporate & Finance Alert, August 4, 2009 "FINRA Sets Rules on Private Placements by FINRA Member Firms," Corporate & Finance Alert, August 4, 2009 "SEC Approves NYSE Rule Change Eliminating Broker Discretionary Voting for the Election of Directors," Corporate & Finance Alert, August 4, 2009 "SEC to Act on Short Selling: Much Ado About Something," Corporate & Finance Alert, June 2, 2009 "FASB Adopts Statement No. 157 -- Fair Value Mark-to-Market Rules," Corporate & Finance Alert, May 5, 2009 "Financing Available in Distressed Markets: Alternatives When Bank or Government Bail Out Funds Are Not Available," Corporate & Finance Alert, April 7, 2009 "Business Development Companies (BDCs): On the Cutting Edge of Alternative Capital in Distressed Markets," Corporate & Finance Alert, April 7, 2009 "A Run on Hedge Funds: Redemption Strategies and Responses," FINalternatives, December 30, 2008 (Lawrence Cohen, Thomas More Griffin) "A Run on the Hedge Funds: Redemptions -- Strategies and Responses," Corporate & Finance Alert, December 16, 2008 (Lawrence Cohen, Thomas More Griffin) "Up Periscope: Guidance on Underwater Stock Options," Corporate & Finance Alert, December 9, 2008 "Director Independence: NYSE and NASDAQ Amend Rules," Corporate & Finance Alert, November 4, 2008 "Auditor's Assessment of and Responses to Risk: Public
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Company Accounting Oversight Board (PCAOB) Proposes New Auditing Standards," Corporate & Finance Alert, November 4, 2008 "SEC Adopts Rule 10b-21 and Amendments to Regulation SHO to Address "Naked" Short Selling and Fail to Deliver Scenarios," Corporate & Finance Alert, October 21, 2008 "Follow Up: SEC Extends Short Selling Ban Rules," Corporate & Finance Alert, October 7, 2008 "SEC Halts Short Selling and Imposes Reporting Requirements to Address Market Turmoil," Corporate & Finance Alert, October 1, 2008 "Venture Capital Firms to Benefit from Proposed Revisions of SEC Rules for Smaller Companies," Financier Worldwide Magazine, November 2007 (Thomas More Griffin, Myriam Rastaetter) "Recent Federal Securities Law Developments Affecting Smaller Public Companies," August 2007 (Lawrence A. Goldman, Thomas More Griffin, Brian DiBenedetto, Myriam Rastaetter) "Sarbanes-Oxley Act and New NYSE and NASDAQ Listing Requirements: Consequences for Private Equity and Mergers and Acquisitions Transactions," Aspen Publishers Corporation, May 15, 2007 (Thomas More Griffin, Mark S. Kuehn) "An Overview of Business Development Companies (BDCs) Under the Investment Company Act of 1940," March 2007 "The Convergence Between Private Equity and Hedge Funds," originally published in the December 2005 issue of Financier Worldwide Magazine, December 1, 2005 "Prime Due Diligence for Second Lien Lending," The Business Advisor, May 26, 2005 "SEC Adopts Significant Securities Offering Reforms," Reprinted with permission from: Inside Newsletter, Winter 2005, Vol. 23, No. 3, published by the New York State Bar Association, One Elk Street, Albany, New York 12207, Winter 2005 (Thomas More Griffin, Brian DiBenedetto) "Sarbanes-Oxley Act and New NYSE and NASDAQ Listing Requirements: Consequences for Private Equity and Mergers and Acquisitions Transactions," January 7, 2004 (Thomas More Griffin, Mark S. Kuehn) "SEC REPORT - The Implications of the Growth of Hedge
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Funds," Corporate & Finance Alert, October 14, 2003 Speaking Engagements Speaker, The Banking Law Section of the New Jersey State Bar Association, "Mezzanine and Second Lien Lending," June 19, 2007 Chair, American Bar Association Section of Business Law Spring Meeting, "Business Development Companies under the Investment Company Act of 1940" Washington, DC. March 15 18, 2007 Speaker, 2006 Alternative Investing Summit: Absolute Return Ponte Vedra Beach, FL. April 26 - 28, 2006 Chair, American Bar Association's Annual Business Law Spring Meeting "Business Development Companies under the Investment Company Act of 1940" Washington, DC, March 15 18, 2007 Speaker, New York Institute of Credit - 26th Annual Credit Program "Alternative Financing" New York, New York, May 17, 2005 Speaker, NYU 2005 Entrepreneurship Conference "Innovation and Competitive Advantage: Conceiving and Protecting the Big Idea" April 16, 2005 Honors/Awards* AV Peer Review Rated by Martindale-Hubbell Representative Matters Mergers and acquisitions counsel to an international jewelry manufacturer based in Long Island City, New York, with locations in Costa Rica, India and Thailand. Counsel to a $1.8 billion investment fund based in New York with funds in the British Virgin Islands. The investment focus of the Alexandra funds is primarily convertible arbitrage. Counsel to an investment banking firm located in New York City that has an investment portfolio of several hundred companies and provides consulting and advisory services. It has engages in venture capital, leveraged and management buy-outs. Counsel to a public company that offers storage and delivery service for owners and distributors of digital content to movie theaters and other venues in its acquisition of a provider of
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broadband video, data and Internet transmission and encryption services. Counsel to large commercial bank in trading of distressed loan portfolio debt. Counsel to public company in connection with private placement/PIPES transactions. Counsel to British Virgin Islands-based $300 million private investment fund in converting the fund into a "master-feeder" structure and in creating Asian sub-fund. Counsel to $100 million (revenues) operator of assisted living facilities in acquisitions, divestitures, financings, restructurings and corporate matters. Counsel to $60 million (revenues) government contracts company in restructuring its debt and in closing its acquisitions of other companies. Representation of medical devices manufacturer in sale of company to strategic buyer in $50 million transaction. Counsel to private investment firm in purchase and restructuring of $25 million unsecured debt instrument with Guangdong Investment Limited in Guangdong Province, China. Representing leveraged buy-out group in purchase of assets of trophy parts manufacturer and distributor in $20 million transaction. Counsel to private investment firm in purchase of $16 million loan portfolio from Japanese bank and California bank. Counsel to acquisition fund in purchasing and financing $10 million (revenues) film production company. Representing private equity fund in purchase of $10 million in equity of public company (games manufacturer) in PIPEs transaction. Counsel and securities counsel to publicly-traded alternative energy company. Counsel to small business investment companies on acquisitions, financings, liquidations, and SBA regulatory issues. *No aspect of this communication has been approved by the Supreme Court of New Jersey. Further information about
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methodologies for rating or selecting attorneys is available on our websites Award Methodology page.
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