Private equity: how long can the perfect storm last?

• Author: Cangemi, Michael P.
• Position: President's page

Corporate trends recently have swung in favor of consolidations and buyouts--a trend being driven, to some degree, by the complexity of business and the availability of private equity (PE) funds seeking good investments. The benefits of consolidation include the advantages of volume (lower cost per unit), leveraging fixed costs, expanding the benefit of other costs (such as advertising) and spreading risks among multiple lines and channels of distribution.

The complexity of business not only includes increased governance and regulation, well-documented in these pages, but also globalization-related international competition. Even after so many major retail mergers, the deals keep coming. Who would have ever thought K-Mart would buy Sears, and Federated Department Stores Inc. would buy May Co., creating the now national mega-chain, Macy's? Macy's itself is now being eyed by private equity buyers.

The current merger and acquisition market is very active due to large sums available from private equity funds and hedge funds that have been growing in popularity since the bursting of the stock market bubble a few years ago. While the credit markets recoiled from high leverage this summer, money is still available to be put to work where there is a reasonable chance of successfully growing a business and the related profits, by strategic investments and the benefits of consolidation.

Big companies have large appetites for acquisitions that would allow them to continue to grow. These sophisticated strategic buyers are always on the lookout to buy companies with good products that would allow them to add sales and gross margin, while eliminating duplicate expenses. But, funding is not the only reason why this is a good time to sell or strategically merge a business!

In what can be described as a "perfect storm," we not only have had huge amounts of private equity funding, but historically low interest rates and a ready availability of bank loans. Some think deals are not about the product, but deals are a part of the business of satisfying the customer with better products, at better prices and at more convenient locations.

For most deals, the purchase price is a multiple of cash flow or earnings. As a result of these favorable conditions, deals are being made at attractive multiples. Strategic planning includes periodic reviews of competitive issues, long-term objectives, market conditions, shareholder value and return on investment. If a sale or...