Despite slowdown, private equity climate still healthy

Crain’s Cleveland Business Journal

BYLINE: KATHY AMES CARR

Cleveland, OH – February 4, 2008 – While the nation’s private equity industry faces uncertain times in the face of a credit crunch that squashed some activity in mid–2007, some local firms say they are cautiously optimistic and remain relatively unaffected by the crisis that’s wreaking havoc across the economy.

Until mid–summer, activity in the private equity industry nationwide had been on a decade–long climb, culminating at the end of 2007 in some $460 billion in total announced buyout deals, according to Thomson Financial, a global provider of financial information.

Investments by private equity firms drive a large share of merger and acquisition activity. Private equity is money from private investors that is invested in companies, usually in the form of stock or other ownership shares.

While private equity activity in general slowed over the last few months of 2007 because of elevated credit risks and a sluggish economy, the reaction in Cleveland’s middle market has not been as harsh as elsewhere, said Robert Keiser, vice president of Thomson Proprietary Research in New York City.

“Cleveland’s market has slowed, but the impact is not as severe as the billion–dollar megadeals,” he said.

Indeed, about 54% of last year’s buyer–related private equity transactions in Ohio were made by Cleveland private equity firms, according to FactSet Mergerstat LLC, a Santa Monica, Calif., tracker of merger and acquisition statistics.

“Cleveland has a pretty high– density private equity industry,” said Beth Laschinger, vice president of Cleveland’s Key Principal Partners LLC.

Middle ground

Middle–market buyout deals are less vulnerable to the effects of the credit crisis than larger transactions, said James Marra, director of business development at Blue Point Capital Partners, one of Northeast Ohio’s largest private equity firms.

“We’re borrowing from finance companies, banks and other entities that are less affected by the problems in the subprime mortgage market,” he said.

On average, transactions are financed more conservatively in middle–market deals compared to larger buyouts, said Kip Clarke, co–head of KeyBanc Capital Markets’ Mergers, Acquisitions & Private Capital Group in Cleveland.

A $50 million deal, for example, typically is financed with one to two banks. Before the credit crunch, larger deals, beginning at $1 billion, included as many as 100 different credit providers, Mr. Clarke said.

After the subprime mortgage collapse, banks were not able to syndicate the loans or bonds; therefore, smaller deals have been affected to a lesser extent. A middle–market deal is about $50 million to $500 million in transaction size, he said.

Tougher market conditions provide more opportunity for Key Principal Partners’ non–controlling investments sector as business owners and management teams seek additional capital while retaining the majority position in their companies, Ms. Laschinger said.

Many companies turn to KPP for private equity capital for growth or acquisitions as senior lenders, typically banks, have less available capital, Ms. Laschinger said.

“We can provide junior capital, or subordinated debt, which often fills the gap between the amount of debt a bank may be willing to lend and the available equity,” she said.

Because smaller transactions are less affected by the debt crisis, firms like CapitalWorks LLC say being in the middle market has advantages.

CapitalWorks CEO Robert McCreary said deals at his Cleveland firm have not changed much.

“I think the lower middle market is an attractive spot to be in,” he said. “The riskier credit has dried up, but we never had access to that risky credit to begin with.”

Brendan Anderson, managing partner of Evolution Capital Partners LLC in Pepper Pike, agrees, describing his sentiment as “excitement” for 2008.

“This sort of market tends to bring big deals and smaller firms closer together,” he said.

What’s in store?

Thomson’s Mr. Keiser said it appears the private equity industry will hold steady in 2008, as the Federal Reserve Board works to restore order to the capital market by reducing the federal funds rate, most recently to 3%, and by returning liquidity to the banking industry.

Interest rates remain historically low, and if gross domestic product growth returns to typical levels by mid–year, Thomson predicts private equity activity will recover.

“The market was overly exuberant last year. However, if there’s a recession this year, all bets are off,” Mr. Keiser said.

According to Thomson, private equity deals represented a small amount of the M&A market until 2001. Then the private equity industry took off, accounting for more than 40% of total announced U.S. merger and acquisition activity at mid–year 2007.

Since the credit crunch started to strangle the economy in mid–July, private equity buyout deals have accounted for 15% of total announced merger and acquisition deals, Thomson reports. Funding terms were either not attractive enough or credit lines were not even available.

“There’s a much more rational expectation this year. Ohio should hold steady barring major economic disruption,” Mr. Keiser said.

Overall, the market continues to see “strong activity” in construction, chemicals and plastics, metals, health care services and wind power, KeyBanc’s Mr. Clarke said.

“Private equity will also do well if we see some positive momentum coming out of the automobile industry, given its huge presence in the Midwest,” he said.

As for John Nestor, senior managing partner and CEO of Kirtland Capital Partners in Beachwood, he agrees with assessments that predict a promising 2008 outlook.

“The market is not going to stop us from doing deals,” he said.

About Key Principal Partners

Key Principal Partners (KPP) is a $1 billion private investment firm that provides expansion capital to profitable middle-market companies with at least $30 million in revenue. The firm has the flexibility to provide any combination of subordinated debt, preferred equity and/or common equity in either non-control (minority ownership) or control (majority ownership) positions. KPP can invest between $10 million and $40 million to facilitate the growth, acquisition, refinancing, deleveraging or liquidity needs of private company owners and their management teams. Affiliated with KeyCorp, KPP is headquartered in Cleveland, and has additional offices in Greenwich, and San Francisco.

About KeyCorp

Cleveland–based KeyCorp is one of the nation’s largest bank–based financial services companies, with assets of approximately $97 billion. Key companies provide investment management, retail and commercial banking, consumer finance, and investment banking products and services to individuals and companies throughout the United States and, for certain businesses, internationally. For more information, visit www.Key.com.