Rise Of Buyout Funds & Implications
Companies Cash Hoard Targeted Soon
Kohlberg Kravis Roberts is looking to collect US$15.5 billion this year for what will be the biggest takeover fund ever formed - topping the loot raised by fellow barbarians Stephen Schwarzman, David Bonderman and Leon Black. Schwartzman's Blackstone Group, Bonderman's Texas Pacific Group and Black's Apollo Management are all raising new war chests that are likely to be filled with more than US$14 billion EACH. KKR's new fund will give it the firepower to pursue bigger takeovers of better-known corporations. The firm, founded in 1976, has already controlled some of the world's most iconic companies including Toys 'R' Us, Texaco and Gillette. The billions flowing into private-equity funds this year have many betting that KKR's record US$31 billion leveraged buyout of RJR Nabisco in 1988 will be shattered.
This week, four buyout firms including Texas Pacific agreed to shell out US$900 million each for Spanish-language broadcaster Univision. New York-based KKR has made tons of money for its investors, and its current buyout fund, formed in 2002, has paper gains of nearly 400 percent. If you were to total the amount of funds raised for buyouts this year alone, you know that these funds will have to make big acquisitions. Its silly to do 20 smaller deals to invest the fund size, its better to do 2 or 3 deals to matches your fund size. Having said that, opportunities will dry up in the US and Europe and thats why a number of the buyout funds have already set up shop with offices in Asia over the past 2 years. Even if 10% of the funds raised by the top 5 were to get to Asia, that would be substantive.
Carlyle Group plans to double the size of its new Japan buyout fund to 200 billion yen (US$1.7 billion) as investors seek to profit from Japan's economic expansion. The fund size might pale in comparison to KKR, Texas Pacific or Blackstone but we have to remember that this is a country specific fund. The firm's second Japan fund will be the biggest targeting acquisitions in the world's second-largest economy. Overseas funds including Fortress Investment Group and RHJ International spent US$2.9 billion buying Japanese companies so far in 2006, betting the nation's fastest economic growth in 15 years will boost corporate profits. Takeovers in Japan almost doubled to US$125 billion last year. Combined net income for 2,250 Japanese companies rose 35 percent to 36.5 trillion yen in the year ended March 31 2006. Japan's economy expanded 3.2 percent in the same period.
Buyout funds profit by selling stakes in their acquisitions through initial public offerings after cutting costs and shedding assets to boost earnings. The early bird should be applauded for its risk taking strategy to step in when no one dared - Ripplewood Holdings LLC, a New York- based fund, reaped an almost fivefold return when it sold two- thirds of Shinsei Bank Ltd., the first Japanese lender acquired by overseas investors. Carlyle's capital raising follows its announcement earlier this month of a US$668 million fund to invest in Asia, and is four times the 50 billion yen raised for its Japan Partners fund in 2001. It's more than double the 82.5 billion yen raised by Mark Chiba's Longreach Group in April. Carlyle and other investors in mobile wireless firm Willcom Inc. plan to sell some of their holding in a 100 billion yen initial public offering early next year, people familiar with the plan said in April. Carlyle, Kyocera Corp. and KDDI paid 220 billion yen for 90 percent of the company in October 2004, with Carlyle taking a 60 percent stake. Carlye last year sold Asahi Security Co., a provider of cash-management services acquired in 2002, and Colin Corp., a failed Japanese maker of blood pressure monitors purchased in 2003.
Carlyle, as a whole group, and New York-based Riverstone Holdings LLC in April raised US$4.5 billion to purchase oil drillers and suppliers of solar and renewable power. Buyout funds gathered a record US$134 billion last year, more than twice the amount amassed in 2004.
I am sure the top management of well managed companies are smiling to themselves, waiting for that phone call from Texas Pacific or KKR. You would find many of the companies being willing sellers are many of the top management have huge options and even parachute agreements (forced out due to a new controlling owner). Most of these buyout funds would however, negotiate an even more attractive package to ensure key top managers stay to improve the company's fortunes. No wonder many CEOs are smiling.
Its also a very good time to do buyouts because never in the history of US companies when you have some many top companies sitting on so much cash in the bank. After enjoying 16 straight quarters of double-digit earnings growth, industrial companies in the Standard & Poor's 500 have stuffed their corporate piggy banks with US$642.7 billion in cash. Not only is that a record, it's a big enough chunk of change to throw off some serious interest revenue which adds to companies' profit. Interest revenue generated by the cash held by industrial companies in the S&P is expected to soar 64% this year after gaining 38% in 2005.
The higher interest payments are coming at an opportune time. S&P 500 companies' earnings are expected to rise just 7.6%. The added interest income might be just enough to help some companies stay above the 10% growth mark. Top companies with the big stash include:
•ExxonMobil - No company in the USA has more cash than the world's No. 1 oil company. It has approximately US$36.5 billion in cash. That's more than the annual gross domestic product of Iceland. Interest generated by its cash pile hit US$946 million in 2005, up 162% from 2004 and 313% from 2003.
•Goodyear Tyre - Goodyear's cash stack of US$1.8 billion doesn't rank in the top 10. But it's a staggering amount considering the company's market value is US$2.3 billion.
•Microsoft - Despite paying a US$32 billion one-time dividend in 2004 and starting an annual dividend in 2003, the company still has US$34.8 billion in cash and short-term investments.
Other notables include Johnson & Johnson with US$17.2 billion, Pfizer with US$15.5 billion (that could be doubled with the recent sale of their comsumer product unit), Cisco with US$15 billion, Motorola with US$14.6 billion (thanks to its superior Razr phone, the amount show grow at a faster pace), Aetna Insurance US$14.4 billion, Merck with US$12.4 billion, IBM with US$12.3 billion and Hewlett-Packard with US$11.9 billion.
A company having lots of cash makes for a great takeover target. Of the lot, HP looks like a sitting duck. Even Motorola is attractive should the controlling family wants to exit. Now, no one is safe from a takeover, just being big is no longer a defense. All in, the enormous amount of cash hoarded by so many companies, coupled with the sizable funds raised by buyout firms, and the rise of hedge funds - all are underpinning the buy side of the companies.