Middle Market Private Equity

Middle Market Private Equity

September 27, 2006

(Greenwich, 9/27/2006) My partner Rob Tucker confirmed today there is a wall of money chasing a shrinking pool of deals in the middle market for private equity transactions. Banks, mezzanine lenders, and equity investors are all trying to get money to work. A business that would have sold for 4.5 times trailing 12 month EBITDA, or cash flow, 5 years ago is now trading at 7.5 times. At those prices an equity investor selling the business at the same multiple 5 years from now would earn high teens returns even it the company hits its business plan. Mezzanine lenders would earn 12-14%.

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This chart shows Thompson Financial data for average transaction multiples by size of deal, with prices ranging up to 9 times cash flow for over $100 million deals. TAggressive lending is driving the high prices.

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Transactions are now being done with total debt levels of almost 5 times cash flow and senior debt over 4 times cash flow. Both numbers are as high or higher than anything we saw at the peak of the last buying binge in 1999 and early 2000. Although there are rumors of credit officers asking questions about companies having a hard time meeeting aggressive plans there is no sign yet of a pullback by lenders.

On Larry Kudlow’s show Tuesday night we had a spirited debate with several guests who were ready to declare a recession. I see no signs of recession yet. But I knnow how to create one if you would like me to do so. Recessions happen when credit markets shift from being cleared by market prices and being cleared by non-price rationing. that happens when there is a sudden deterioration in collateral values for existing loans (as in 1989-92 when land prices fell for the first time since the 1930s) or in the cash flow levels specified in loan documents or when the order goes out from central command (the Treasury or Fed) to stop lending (as in 2001-2004). these conditions create a temporary ‘blackout’ in credit markets during which it is difficult to get credit at any price. We should keep our eye on private equity loans and real estate loans as potential sources of a blackout.

JR

John Rutledge

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