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Capital Ideas for Private Business

Outlook For 2008

A Private Equity Perspective

By Jeff Johnson, Principal
Northern California Office, Corporate Finance Associates
& Roy Graham , Principal
San Antonio/Austin Office, Corporate Finance Associates

As Bob Dylan sang, "the times, they are a-changing." Against a backdrop of roiling credit markets, ten private equity groups joined 35 of our dealmakers toward the end of February at Corporate Finance Associates' annual winter conference in Orlando. Armed with an ample cache of dry powder in the form of investment capital, our guests joined a panel discussion to share their outlook on deal activity in 2008. With market conditions so volatile, we checked back with our panelists for updates at press time. We think you will be interested in what they said.

When asked whether they plan to invest more or less in 2008 than in 2007, our panelists' answers reflect a general optimism. Aiden Riordan, Partner Calvert Street Capital Partners, expects an increase in opportunities in 2008 "there is a lot of (equity) capital in the market and we could see a very strong year." However alluding to valuations, he observed that, "we could see significant price dislocations." Phil Curatilo, Principal Key Principal Partners is enthusiastic about opportunities for his firm. "We did 16 transactions including 5 platform deals and 11 follow-on opportunities in 2007. We invest both sub-debt and equity and therefore have great flexibility. Challenging credit markets exist so we expect to do far more non-control transactions in 2008. 2008 should be a great year for us with more opportunity for investment than 2007."

Others echoed the upbeat assessment. David Malizia, Managing Partner Westshore Capital Partners, "expects to invest more in 2008." Malizia added: This is an election year and there is concern that capital gains tax rate could be increased so many sellers feel this is a good year to sell." Lane Faison, Principal Copley Capital says he too "expects an active 2008." When contacted for an update, Lane added, "In the past 30 days many lenders have become more conservative in their underwriting criteria and risk tolerance. Fees and terms are becoming more lender friendly. However, there are still lenders who are active in our market. In our view good businesses continue to get financed however storied situations are difficult. We continue to think 2008 will be an active year."

Tightening credit markets will likely push investor equity contributions higher and increase the cost of capital to acquirers as they make increased use of subordinated debt. Riordan pointed out that a "shrinkage in the debt/lending market causes a flight to better quality deals but multiples remain steady for quality opportunities." Malizia said, "senior debt to EBITDA ratio has reduced by a quarter to a half multiple going from 3x to 2.5x. Total debt to EBITDA has reduced from 4x to 3.5x." He went on to say that, "the cost of senior debt has increased from an average of LIBOR +300 basis points in 2007 to an average of LIBOR + 450 as of today." Faison commented, "the lending community is shrinking, but quality lenders remain so the debt market will hold up." A senior commercial banker with a large national bank, who asked not to be identified, told CFA at press time, "Our terms and criteria are changing daily. Our pricing has gone up about 50 basis points in the past two weeks. There is somewhat of a black box element about our environment now."

Despite numerous doomsday headlines in the press, the views of our panelists seem to reflect a generally upbeat outlook. This may in large part, reflect the fact that the press focuses on Wall Street mega deals. There continues to be a bifurcation in the credit markets serving the mega deals and those focused on the middle-market. While the impact of the housing downturn and securitized debt crisis could ultimately flood over into the middlemarket playing field, its impact to date has been only modest. Weaker business valuations computed by domestic acquirers pinched by decreased leverage availability and/or the use of higher priced subordinated debt, may be at least partially offset by foreign buyers anxious to capitalize on a weak dollar.

With modest reservation, it appears that 2008 middle-market M&A activity may not deviate greatly from a strong 2007. Yet there is a lingering black box element about our environment now. To further understand how these market conditions affect you, call your local CFA dealmaker. We will give you additional insight, augmented with a regional slant that personalizes this outlook to your market.


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