effects recession

8/6/2019 Effects Recession

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EFFECT OF THE RECESSION ON

PRIVATE EQUITY AND LEVERAGED

BUY-OUTS (LBOS): BURNED, BUT THE

PHOENIX IS RISING FROM 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

([email protected])

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 hispractice 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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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 mortgage-

backed 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

57

92116

197

155

33

144

246

295

685659

190

23

71

0

100

200

300

400

500

600

700

800

2003 2004 2005 2006 2007 2008 H1 2009

Source: Dealogic/Preqin

Capital Called Upby Buyout Funds($bn)

Total Buyout DealVolume ($bn)

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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Number and Value of Deals* by Year 2000-2009

1363

693

798

962

1334

2034

2547 2556

1846

925

102.3 66.4111.1 143.6

245.6294.6

685.1 658.9

189.8

76.4

0

500

1000

1500

2000

2500

3000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

*All data excludes add-on deals

No. of Deals

AggregateDeal Value($bn)

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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Announced US Private Equity Deal Volume

335 282 309412

536

694840

962

636

90

481

302

371

467

622

643

782 565

436

94

816

584

680

879

1,158

1,337

1,622

1,527

1,072

184

0

400

800

1200

1600

2000

2000 2001 2002 2003 2004 2005 2006 2007 2008 1Q 2009Source Dealogic

This chart captures transactions where the buyer is a US or foreign private equity firm acquiring a US based target

Total US volume

Disclosed US volume

Non-disclosed US volume


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Announced US private equity deal value

$63.8

$36.9

$66.4$80.0

$152.3

$191.8

$447.9

$425.7

$77.4

$5.5$0

$100

$200

$300

$400

$500

2000 2001 2002 2003 2004 2005 2006 2007 2008 1Q 2009

$ in billions

Disclosed US value ($B)

Source: Dealogic

This chart captures transactions where the buyer is a US or foreign private equity firm acquiring US-based targets

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 LBO

$(bn) # $(bn) #

1998 1,428.67 10,623 33.93 278

1999 1,447.09 9,812 58.81 461

2000 1,414.87 9,437 43.89 524

2001 723.70 7,369 18.91 257

2002 383.55 6,505 48.57 377

2003 459.83 6,269 56.33 4442004 651.28 6,727 109.03 616

2005 913.38 6,510 132.06 843

2006 1,027.46 8,224 397.01 1,088

2007 1,022.51 8,642 377.15 1,020

2008 872.21 7,286 61.82 710

2009 YTD 417.26 3,939 14.47 341

Sources: Dealogic


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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

22 20 18

37

55 52 48 5063

9580

107

124134

149

128118

212

121

195

164

194

120

158

72

53

35

86

0

50

100

150

200

250

Q12003

Q32003

Q12004

Q32004

Q12005

Q32005

Q12006

Q32006

Q12007

Q32007

Q12008

Q32008

Q12009

Q32009

Source: Preqin

AggregateCapitalRaise

d

($bn)

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.


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Global fundraising efforts

249

399

494 499

409

41

$120.2

$230.8

$379.9

$448.7$452.4

$39.2

0

100

200

300

400

500

600

2004 2005 2006 2007 2008 1Q 2009

$ in billions

# of funds closed

Funds raised

Source: Preqin

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)

36,181.8

264,137.9

300,833.7

229,770.9

165,786.9

71,898.5

32,516.845,852.9

57,997.2

93,879.9

49,062.5

70,346.5

46,513.8

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009YTDYear to date: 1/09-6/30 /09

Source: Reuters Buyouts

Mezzanine funds

Buyout funds

Secondary funds raising equity capital also suffered during the Greatest Recession. See

the chart below.


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Capital raised by secondary funds ($B)

0.8 0.80.4

2.62.2 2.1

4.54.1

3.5

6.4

5.66.1

15.1

7.4

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: Probitas Partners

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

4% 4%

51%

15%

25%

0

10

20

30

40

50

60

H1 2010 H2 2010 2011 Unsure at

Present

Not Investing

for at Least

Two Years

Source: Preqin

ProportionofRespond

ents(%)

Investors pondering going into private equity funds are concerned with exit opportunities.

This issue is illustrated in the graph below.

Announced US-based private equity sell-side deal volume

12 13 1629

52

112 121

154

102

25 15

34

75

123

187

132

185

79

14

5

3728

50

104

175

299

253

339

181

19

0

100

200

300

400

2000 2001 2002 2003 2004 2005 2006 2007 2008 1Q 2009

Disclosed US volume

Non-disclosed US volume

Total

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)

$20.36

$21.31

$20.26

$2.52$1.74

0

20

40

60

80

100

2005 2006 2007 2008 2009 YTDYear to date: 1/09 - 9/09

Nu

mberofdeals

0

5

10

15

20

25

Va

lueinbillions

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 mid-

size 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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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 TRANSACTION

3/2/2010 Prudential PLC acquisition of AIG Asian life insurance business for $35.5billion.

3/3/2010 Hedge fund Elliott Associates LP bids $1.8 billion for Novell Inc.

3/3/2010 Dow Chemical to sell Styron plastics business to private equity fund BainCapital Partners for $1.63 billion.

2/3/2010 Private equity fund Platinum Equity of Beverly Hills buys WoodManufacturing/Genmar holdings, $1.1 billon in sales.

2/11/2010 Affiliated Managers Group Inc. acquires Pantheon Ventures, Londonprivate equity fund of funds, for $775 million.

2/25/2010 SkillSoft of Dublin (UK) $1.1 billion - sale to Berkshire Partners, Advent,Bain Capital - in going private transaction.

2/12/2010 Oak Hill sells Duane Reade to Walgreen $1.1 billion.

2/16/2010 Express retail chain $200 million IPO, owned by Golden Gate Private

Equity Inc.

2/2010 Simon Property Group $10 billion all cash bid for General GrowthProperties.


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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 PublicOfferings to Raise Money to Invest In and Acquire DistressedMiddle Market Companies," Corporate & Finance Alert,September 8, 2009

"SEC Proposes Rule Amendments to Facilitate Rights ofShareholders to Nominate Directors," Corporate & Finance Alert,August 4, 2009

"FINRA Sets Rules on Private Placements by FINRA MemberFirms," Corporate & Finance Alert, August 4, 2009

"SEC Approves NYSE Rule Change Eliminating BrokerDiscretionary 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-MarketRules," Corporate & Finance Alert, May 5, 2009

"Financing Available in Distressed Markets: Alternatives WhenBank or Government Bail Out Funds Are Not Available,"

Corporate & Finance Alert, April 7, 2009

"Business Development Companies (BDCs): On the Cutting Edgeof Alternative Capital in Distressed Markets," Corporate & FinanceAlert, April 7, 2009

"A Run on Hedge Funds: Redemption Strategies andResponses," FINalternatives, December 30, 2008 (LawrenceCohen, Thomas More Griffin)

"A Run on the Hedge Funds: Redemptions -- Strategies andResponses," 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 NewAuditing Standards," Corporate & Finance Alert, November 4,2008

"SEC Adopts Rule 10b-21 and Amendments to Regulation SHOto 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 toAddress Market Turmoil," Corporate & Finance Alert, October 1,2008

"Venture Capital Firms to Benefit from Proposed Revisions ofSEC Rules for Smaller Companies," Financier WorldwideMagazine, November 2007 (Thomas More Griffin, Myriam

Rastaetter)

"Recent Federal Securities Law Developments Affecting SmallerPublic Companies," August 2007 (Lawrence A. Goldman, ThomasMore Griffin, Brian DiBenedetto, Myriam Rastaetter)

"Sarbanes-Oxley Act and New NYSE and NASDAQ ListingRequirements: Consequences for Private Equity and Mergers andAcquisitions Transactions," Aspen Publishers Corporation, May15, 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 FinancierWorldwide Magazine, December 1, 2005

"Prime Due Diligence for Second Lien Lending," The BusinessAdvisor, May 26, 2005

"SEC Adopts Significant Securities Offering Reforms," Reprintedwith 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 MoreGriffin, Brian DiBenedetto)

"Sarbanes-Oxley Act and New NYSE and NASDAQ ListingRequirements: Consequences for Private Equity and Mergers andAcquisitions Transactions," January 7, 2004 (Thomas MoreGriffin, 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 BarAssociation, "Mezzanine and Second Lien Lending," June 19,

2007

Chair, American Bar Association Section of Business Law SpringMeeting, "Business Development Companies under theInvestment Company Act of 1940" Washington, DC. March 15 -18, 2007

Speaker, 2006 Alternative Investing Summit: Absolute ReturnPonte Vedra Beach, FL. April 26 - 28, 2006

Chair, American Bar Association's Annual Business Law SpringMeeting "Business Development Companies under the

Investment Company Act of 1940" Washington, DC, March 15 -18, 2007

Speaker, New York Institute of Credit - 26th Annual CreditProgram "Alternative Financing" New York, New York, May 17,2005

Speaker, NYU 2005 Entrepreneurship Conference "Innovationand Competitive Advantage: Conceiving and Protecting the BigIdea" April 16, 2005

Honors/Awards*

AV Peer Review Rated by Martindale-Hubbell

Representative Matters

Mergers and acquisitions counsel to an international jewelrymanufacturer based in Long Island City, New York, with locationsin Costa Rica, India and Thailand.

Counsel to a $1.8 billion investment fund based in New York withfunds in the British Virgin Islands. The investment focus of theAlexandra funds is primarily convertible arbitrage.

Counsel to an investment banking firm located in New York Citythat has an investment portfolio of several hundred companiesand provides consulting and advisory services. It has engages inventure capital, leveraged and management buy-outs.

Counsel to a public company that offers storage and deliveryservice for owners and distributors of digital content to movietheaters and other venues in its acquisition of a provider of


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broadband video, data and Internet transmission and encryptionservices.

Counsel to large commercial bank in trading of distressed loanportfolio debt.

Counsel to public company in connection with privateplacement/PIPES transactions.

Counsel to British Virgin Islands-based $300 million privateinvestment fund in converting the fund into a "master-feeder"structure and in creating Asian sub-fund.

Counsel to $100 million (revenues) operator of assisted livingfacilities in acquisitions, divestitures, financings, restructuringsand corporate matters.

Counsel to $60 million (revenues) government contracts company

in restructuring its debt and in closing its acquisitions of othercompanies.

Representation of medical devices manufacturer in sale ofcompany to strategic buyer in $50 million transaction.

Counsel to private investment firm in purchase and restructuringof $25 million unsecured debt instrument with GuangdongInvestment Limited in Guangdong Province, China.

Representing leveraged buy-out group in purchase of assets oftrophy parts manufacturer and distributor in $20 million

transaction.

Counsel to private investment firm in purchase of $16 million loanportfolio from Japanese bank and California bank.

Counsel to acquisition fund in purchasing and financing $10million (revenues) film production company.

Representing private equity fund in purchase of $10 million inequity of public company (games manufacturer) in PIPEstransaction.

Counsel and securities counsel to publicly-traded alternativeenergy company.

Counsel to small business investment companies on acquisitions,financings, liquidations, and SBA regulatory issues.

*No aspect of this communication has been approved by theSupreme Court of New Jersey. Further information about


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