LBOs: Could more mean worse?

Bankers are confident that the record Kohlberg Kravis Roberts has held since 1989 for the biggest ever buyout – its $25 billion purchase of RJR Nabisco – will be broken in 2006. But that will mean private-equity firms will have to band together with even more of their competitors in club deals.

Although 2005 will be remembered as a watershed year for large, club LBOs, and average deal size was the highest on record, only two buyouts passed the $10 billion mark in 2005 – the $15 billion deal for Hertz and the $11.8 billion one for Sungard. “The Sungard deal opened everyone’s horizons,” says Boon Sim, head of M&A for the Americas at Credit Suisse. “Now deals of $20 billion to $30 billion will come.”

Conditions are certainly ripe for even larger transactions. Leverage multiples for LBOs, in the seven to eight times ebitda range, are still lower than they were in the 1980s. At the same time, individual private equity firms are raising record-breaking new funds. At the beginning of 2005, $3 billion to $4 billion was a big fund, at the end of the year $10 billion was not unusual. In 2006 the indications are that sponsors are going to be raising even bigger funds, with the biggest players raising $12 billion or more.

But no private equity fund wants to take on the single-risk exposure of a deal the size of an RJR Nabisco, even if they could, which means still bigger sponsor groups will emerge. For all the talk about large bidding consortiums in 2005, only one deal that closed in 2005 had as many as seven consortium members and that was the one for Sungard.

Banding together

In January, another seven firms – Blackstone, Carlyle, KKR, Permira, Hellman & Friedman, Alpinvest and Thomas H Lee – made a bid worth $8.8 billion for Dutch business information company VNU. Bankers say that the number of private equity firms banding together is set to rise. Mark Epley, managing director and head of the financial sponsors group in the US for Deutsche Bank, says: “This year, I think we are going to see still bigger consortiums for the best-quality companies. There are several in the works already.”

For the sponsors, there are obvious drawbacks to club deals, such as the need to share market information with competitors. One banker says that when the Sungard deal was done, it was difficult to persuade private equity sponsors that they should educate their competitors in the merits of a club deal at all.

Value added

That might be changing, but won’t having even more sponsors involved in club deals mean it is impossible to run a target company successfully? Cris Condé, CEO of Sungard, is one of the few people in the market who knows how large private equity consortium work in practice. He is impressed. “The firms worked together in a very collegial manner before and after the deal, and on any one issue we only deal with a sub-committee of two or three of them, so it is not an unwieldy structure,” he says. “In fact, one thing I underestimated was the value they would add as they can bring ideas from many other companies.”

However, running the day-to-day business is one thing, deciding how and when to exit a business when there are so many interested parties could be far more challenging – and no one has tested that part of the club LBO process yet. Getting eight, nine or more consortium members to work together could be even more difficult.