Federal stalemate on bailout plan will freeze up capital markets

Congressional rejection of a $700 billion bailout package for the financial industry on Monday will cause a more dramatic slowdown within the M&A marketplace, according to several industry insiders. The industry has already seen an impact from recent collapses of financial giants and struggles on Wall Street.

"What is taking place now will have repercussions through every market," said Paul Stewart, a partner with PS Capital Partners LLC, a Milwaukee-based private equity holding firm. "(The lack of) credit will end up affecting leverage needed to buy a company."

Howard Lanser, director and investment banker with Robert W. Baird & Co. Inc.’s Chicago office, said a further tightening in the M&A marketplace has already started.

"In the last couple of weeks, we’ve been in uncharted territory," he said. "(Monday’s) failure injected a high degree of uncertainty in the marketplace."

Baird’s middle-market deal volume has yet not been widely affected by credit unavailability, Lanser said, but he believes the M&A marketplace could soon tighten further.

"The next couple of weeks will be the true tale of how mergers and acquisitions will go (for the rest of the year)," he said. "M&A will go the same route as the credit markets. We expect October to be a watershed month in the credit markets."

Several investment bankers believe that the overall number of M&A deals will slow this year and into next year because of the federal inaction and subsequent impact on Wall Street.

"I think credit will get worse before it gets better," said Linda Mertz owner and managing director of Waukesha-based Mertz Associates. "It will deepen and I think there is a chance that we could enter a real recession. I think there are going to be virtually no traditional LBO deals in the next three months – that means no money down and a lot of debt."

John Emory Jr., president and CEO of Milwaukee-based Emory & Co., said Monday’s stock market plunge would cause additional slowdown in the M&A world. The Dow Jones Industrials Average recorded an all-time record one-day collapse of more than 777 points.

"When you have the largest point drop ever in the history of the Dow, that’s not a positive development for most people," he said. "The macro economic (developments) of the last two weeks look to be negative for the next couple of quarters. There will be fewer new processes started next month than there would have been without the stock market drop."

M&A activity around the nation and in the Midwest has seen slowing activity as the year progresses, according to two recent reports by Baird and Chicago-based William Blair & Co.

There were 233 middle market mergers in August, an almost 35-percent drop in August, 2007 activity, according to Baird’s September Merger Monthly, a monthly report on M&A activity. There have been 2,101 middle-market transactions through the end of August, a 26-percent decline from year to date 2007, the report also states.

The U.S. deal volume in August was the second-lowest monthly total for 2008, says William Blair’s Merger Tracker report, and is the second lowest month over the last two years, with average deal size of about $183 million, compared with $307 million for average year-to-date deal size and $423 million for 2007 year to date.

Many investment bankers in the Milwaukee M&A marketplace said their firms have solid numbers for the year, despite the national slowdown.

"I have at least three deals I still expect to close this year, but they are not dependent on financing," Mertz said.

Stewart said the first eight months of 2008 had been good for many Milwaukee-area M&A firms.

"The markets have been strong and the businesses of the size we deal with, the $25 million to $70 million businesses, have been having good years," Stewart said. "Our portfolio businesses are all having a strong year when we thought this year would be soft."

Ron Miller, managing director with Milwaukee-based Cleary Gull Inc., said his firm has not yet seen a slowdown because of larger economic issues.

"We continue to progress on a very strong backlog of business," Miller said. "I’ve actually had a very strong number of leads in the last three weeks of healthy companies looking to sell or recapitalize their businesses."

Most of Cleary Gull’s clients are not having difficulty financing their deals, Miller said, because middle-market banks are still active in lending.

"Until they pull back, I don’t think lower middle-market M&A will be further impacted," he said. "Most transactions are progressing on track and on time. But we are keeping a very close eye on them."

There are opportunities for both buyers and sellers in the potential slowdown, Mertz said.

"If you’ve got a good quality company, it’s a wonderful time to sell," she said. "Private equity will have a flight to quality – it will be like a bunch of guys sitting around an ice cream sundae. PE has a ton of money and they need to place it."

Miller agreed.

"We’re still in the strongest part of the M&A market, the segment that is least dependent on the broader debt markets which are clearly suffering," he said.

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