It was perhaps no surprise to the financial community that the buyer in the just-announced deal for the operators of Sizzler Restaurants is not another restaurant company but rather a private equity firm. Swelling cash coffers and pressure to deliver returns to investors has accelerated merger and acquisition activity by equity funds, many involving publicly-held companies that will return to the private sector as a result of the acquisition. The trend is not entirely new equity firms have for years included buyout funds for outright acquisitions in addition to their investment activities but the most recent deals reflect a willingness to pay top dollar for some of these acquisitions and to hold the investments for longer periods of time. “The way it’s different today is these are enormous deals in which you’re talking about high valuation levels,” said Steve Weisner, a partner at private investment firm Zuma Capital Partners in Warner Center, commenting on the trends in general and not the WRC deal. “Private equity groups are just as aggressive, if not more aggressive than strategic buyers.” Whereas strategic buyers, other corporations in the same or similar market sectors, have traditionally been the highest bidders because their expertise allows them to reap the greatest potential from the companies they acquire, today’s private equity firms can often add the same, if not more value to an acquisition, resulting in sizable returns for their investors. Private equity firms that acquire publicly-held companies are taking them private and seeing huge savings from the costs of complying with Sarbanes-Oxley legislation that go straight to the bottom line. What’s more, these private equity firms have the flexibility to make hard decisions about retooling the company, like closing locations, with much less concern for the short term effects of these types of moves on earnings and revenues. Along with Sizzler, whose parent company, Worldwide Restaurant Concepts Inc., has agreed to be bought by Australian buyout firm Pacific Equity Partners, The Neiman Marcus Group, Toys R Us and others have all inked deals with private equity firms in recent months. Last year, buyout funds accounted for $128.7 billion worth of M & A; activity in the U.S., representing 15 percent of all M & A; activity, according to data provided by Dealogic, a U.K.-based company that provides research, software and other services to the capital markets industry. That is up from just $18.6 billion, or 1 percent of all M & A; activity in 2000. “There’s a tremendous amount of money looking for deals, and they (private equity funds) are definitely helping drive some of the M & A; activity,” said Brent Reinke, corporate partner at Westlake Village law firm Musick, Peeler & Garrett LLP. Dissatisfied with market Dissatisfied with the returns in the stock market, investors have moved with alacrity into equity and hedge funds, spawning new funds and swelling the war chests of existing ones. In April Goldman Sachs announced it had raised $8.5 billion for its new private equity fund. And hedge funds, which often include buyout funds, now control about $1 trillion of investment capital. “Private equity funds more so than mutual funds have discretion to find value and create value on an active basis,” said Stephen H. Watkins, general partner at L.A.-based venture fund Arcturus Capital. “If a private equity can say I can get you 15 percent or 20 percent, that’s very good compared to what their bond portfolio looks like or their stock portfolio looks like.” In years past, and especially through the 1980s, buyout firms earned a reputation for acquiring distressed companies and selling off the pieces. But in recent years, particularly as these funds have grown in size, private equity firms have acquired strong companies with significant growth potential or they’ve chosen companies with slower growth, but considerable opportunity for improvement. Consider the deal under which Texas Pacific Group and Warburg Pincus will acquire Neiman Marcus for about $5.1 billion. Hardly distressed, Neiman Marcus has seen double-digit same-store sales increases in its last six quarters, and the company reported net income rose 87 percent in fiscal 2004 to $205 million or $4.19 per share. Like the retail sector, restaurants are also attracting attention from equity funds. “You’re starting to see a lot more interest in the restaurant space,” said Eric Wold, managing director, equity research, restaurants and consumer at Merriman Curhan Ford & Co. in San Francisco. “It’s not distressed companies. It’s companies that are doing well, but aren’t deemed sexy by stockholders.” Troubled by an outbreak of E. coli at its Pat & Oscar’s division, skimpy same-store sales increases in its U.S. Sizzler operation and a weak earnings report, WRC’s stock hovered in the $3.00 to $3.50 range until December when the company announced that it had hired Houlihan, Lokey, Howard and Zukin to explore strategic alternatives. The sale of WRC, which is subject to several approvals, for about $7 per share or about $210 million in cash, amounts to about 6.8 times trailing EBITDA, a price that falls within the range for the sector, said Wold. But he added that Pacific Equity will ultimately pay a lower price because the company’s EBITDA is currently higher than what it will be once WRC becomes private. “That includes a lot of the costs of being public,” Wold said. “So even though it’s 6.8 times trailing EBITDA, that multiple is actually lower if you consider the costs that would have been incurred that now won’t be.” Fixing operations Perhaps most important, the acquisition would allow WRC to retool the operation, shedding unprofitable locations, without the pressure of shareholders anxious for returns looking over the company’s shoulder. “If you’re management, you would much rather be private than public,” said Gary Clark, an entrepreneur who heads the Westlake Village/Santa Barbara chapter of angel investment group Tech Coast Angels. “You don’t have to manage a stock price which is arbitrarily set and you don’t have to report on a quarterly basis and meet analysts’ expectations. So you can take a longer term view of the types of things you want to do strategically. You’re not going to be judged on a three-month report card and maybe lose your job because of it.” Ironically, though, the large volume of capital flowing into equity funds could put these managers under pressures similar to those of their public company counterparts. Some believe that the sheer volume of money chasing deals will drive up valuations, making it more difficult to generate the kinds of double-digit returns investors expect. And institutional investors, many of which have moved into equity and hedge fund allocations, are facing big payouts as baby boomers start to retire, increasing the expectations on these equity funds to perform. “There’s a lot of pressure on state and corporate pensions to assure they’ve got enough money to pay the bills when people start walking out the door, and that’s one of the things that’s propelling them into other investments,” said Weisner. “It all boils down to demographics. They’ve got enormous bills to pay, and the only way to pay them is by getting higher returns.”
