Like many large corporations, Reliance Steel & Aluminum stopped making acquisitions after the 2008 financial crisis.
A self-described “aggressive acquirer of companies,” the downtown L.A. metals processing giant had purchased 40 companies over the preceding decade, but the economic collapse threw Reliance’s expansion plans and the entire mergers and acquisitions market into limbo.
“When the economy kind of crashed in the back half of 2008, it just created a lot of uncertainty and threw a lot of companies into loss positions,” said Reliance Chief Executive David Hannah. “We’re not really looking (to buy) what you might call a fixer-upper. We’re looking for good companies that perform well relative to market conditions, and those opportunities in our industry just haven’t been there.”
That was then. Now, things are getting back to normal.
Reliance has announced two acquisitions since October – its first activity in more than two years – and Hannah expects more.
“Going forward there will be more opportunity in the M&A environment than we’ve seen,” he said.
In fact, local M&A is on an upswing after a sharp decline in 2009, according to data compiled for the Business Journal by Lazard Middle Market LLC. Through November, the number of Los Angeles County deals has already exceeded 2009’s total, and the year should end with almost 600 transactions, an increase of nearly 20 percent. The pace is picking up, too. Since June, deal volume is up 41 percent over a year ago.
Dealmakers said Los Angeles is positioned for a strong rebound since the area is flush with middle-market companies, which have been at the heart of the M&A recovery.
The region has had its share of megadeals, including billionaire Patrick Soon-Shiong’s decision to sell Abraxis BioScience Inc. for $3 billion, even though financing is still tough to obtain for huge transactions. Small deals, meanwhile, continue to be seen as not worth the risk.
Underpinning this middle-market recovery is the increasing availability of financing – including high-yield debt, equity and bank loans – from both private equity investors looking for return on capital and corporations looking to expand.
Leonard Green & Partners LP, L.A.’s second largest private equity firm, had its busiest year in history, announcing 11 transactions, including last month’s headline-grabbing $3 billion acquisition of retailer J. Crew Group. Most years, the firm doesn’t do more than three or four deals.
Meanwhile, so-called strategic buyers – companies such as Reliance or downtown L.A.’s Aecom Technology Corp. that are looking to expand by gobbling up competitors – have raised substantial sums in the debt and equity markets to make acquisitions.
“There’s some very strong indicators that would suggest we will continue to see growth in the M&A market,” said John Mack, executive vice president and co-head of corporate finance for Imperial Capital LLC, a middle-market investment bank in Century City.
Private equity pullback
After the financial crisis, the only bright spots to be found in M&A were in niches designed to do well in unsettled markets, including distress investing. Local firms specializing in reviving struggling companies, such as Oaktree Capital Management LP in downtown Los Angeles and Beverly Hills’ Platinum Equity LLC, remained active.
For most L.A.-area firms, though, deal-making fell off a cliff. Fewer than 500 deals were announced in Los Angeles in 2009, off more than 40 percent from prerecession highs.
“You had a very rapid shock to the system,” said David McGovern, managing partner and founder of El Segundo private equity firm Marlin Equity Partners. “From a buyer’s perspective, most people were scared of what was next.”
Financing dried up, he said, as many lending sources “evaporated overnight.”
Prior to the recession, it was not uncommon for private equity buyers to use substantial leverage to pull off deals, but that strategy quickly became untenable.
Marlin – which announced 10 deals this year, up from eight in 2009 – has stayed active by keeping debt limited, typically to no more than 50 percent of acquisition size, McGovern said. What’s more, the firm has targeted companies with steady revenue streams and that offer “mission-critical” services.
Among its moves this year, the firm bought Datafarm Inc., a Marlborough, Mass., company specializing in regulatory compliance software for life sciences companies – a service not dependent on the economy.
“We focused on companies that we didn’t think could evaporate overnight,” he said.
Now, however, financing markets are beginning to open up, he said. Banks are increasing lending, stock offerings have become viable and the high-yield debt markets are recovering.
Firms such as Levine Leichtman Capital Partners, a Beverly Hills private equity firm with $5 billion under management, have ramped up investment activity. Levine Leichtman, which did just one deal last year, announced eight this year, including the $113 million acquisition of the franchise businesses of New York-based NexCen Brands Inc.
But the stabilization of the markets has not been good for everyone.
Oaktree, which is built to exploit inefficient and fear-driven markets, thrived in 2008 and 2009. The firm bought a number of companies during the recession, including many undergoing bankruptcy reorganization.
Co-founder and Chairman Howard Marks said Oaktree has had to rein in its expectations as the M&A market has found equilibrium. While the firm hasn’t stopped doing deals – as evidenced by a recent $4 billion offer, along with two partners, to take control of Dallas natural gas company Exco Resources Inc. – the investment bonanza has ended.
“Investor sentiment has come back, capital has come back, risk-taking has come back,” Marks said. “When those things happen, prices rise and prospective returns fall.”
Growth opportunities
Stable markets also draw in strategic buyers, which have been some of the most active M&A players this year in Los Angeles.
During the recession, many companies cut costs and laid off staff. With emerging signs of a recovery, many of those companies are now finding extra cash on their balance sheets due to the streamlining efforts. The Federal Reserve said this month that corporate cash had jumped to a record $1.93 trillion.
That cash, combined with equity from stock offerings and borrowed funds at relatively inexpensive rates, has fueled a surge in corporate M&A.
“They are sitting on more cash than they ever had. The strategics are very, very active, and I think they are going to get more active over the course of the next year,” said Bryant Riley, chairman of West L.A. investment bank B. Riley & Co.
This month, HCP Inc., a health care-focused real estate investment trust in Long Beach, announced the biggest local deal of 2010 with its $6.1 billion acquisition of HCR ManorCare, a Toledo, Ohio-based nursing home operator. To pay for the strategic purchase, HCP said it will sell 31 million shares of stock.
Meanwhile, Aecom, which has a history of acquisitive growth, announced five acquisitions this year, including three of the county’s 25 largest deals. The global engineering firm paid $355 million in August for Springfield, Va.’s McNeil Technologies Inc. to fortify its growing cybersecurity business.
“They’ve been making acquisitions for a number of years, but I think this year was somewhat of a bulge,” said John Rogers, an analyst who follows Aecom for Great Falls, Mont.-based D.A. Davidson & Co.
Aecom Chief Financial Officer Michael Burke said in a statement that the McNeil acquisition represents a major step in the company’s effort “to put our balance sheet to work to fund strategic acquisitions in today’s highly attractive M&A market.”
Bank deals are on the rise, as well.
This month, Koreatown bank holding companies Nara Bancorp Inc. and Center Financial Corp. announced plans to merge in a $286 million all-stock transaction – the largest community bank transaction in the Western United States in three years, according to an analysis by D.A. Davidson.
Alvin Kang, chief executive of the combined bank, said the deal could accelerate an anticipated consolidation in the Korean-American banking niche.
“You have to expand beyond your primary markets,” Kang said. “On a long-term basis, (this merger) probably puts us in the best position to grow, not only organically, but acquisitively.”
Studio deals
Some of the year’s highest-profile – and most entertaining – deals came out of Hollywood.
George Soros gave up his stake in the DreamWorks SKG film library through a $400 million deal with Viacom Inc. And Walt Disney Co.’s decision to unload the Miramax film library, which includes movies such as “Pulp Fiction,” brought out a number of billionaires, including Ron Tutor, Thomas Barrack, Ron Burkle, and brothers Tom and Alec Gores. A team led by Tutor and Barrack ultimately bought Miramax for $663 million.
Michael Lang, who consulted on the acquisition and was recently named chief executive of Miramax, said he’s not surprised there have been so many entertainment deals.
“Typically M&A within the media business is driven by momentum,” said Lang, who is unsure the momentum can be sustained.
Still, while M&A has picked up, the deal-making environment is far removed from the heady prerecession days. Leverage levels, for instance, are unlikely to approach the old levels.
According to an analysis by Imperial Capital, total debt in leveraged buyouts this year was a healthy and not-too-risky 4.6 times EBITDA, or earnings before interest, taxes, depreciation and amortization. Debt to EBITDA ratio is a common metric measuring the debt load and default risk for companies, where a higher ratio equals more risk. In 2007, debt levels approached six times EBITDA, while some of the riskiest deals exceeded 10 times EBITDA.
“We’re back to the fundamentals of M&A investing,” said Imperial Capital’s Mack. “Buyers are considerably more careful about how they go about looking at transactions. Nobody wants to be caught doing a transaction that they haven’t really considered.”
