KEY POINTS:
Two years ago, private-equity firms were literally knocking on the doors of businesses they wanted to buy. Debt was cheap and the opportunity to load a deal up with debt and make money seemed boundless.
In New Zealand, 17 major leveraged buy-outs were completed, transferring brands such as Tegel, Griffins, Waste Management, Healthries and Independent Liquor into the hands of private equity.
But mid-way through last year the big deals dried up.
Just two major private-equity deals to buy New Zealand companies went ahead in 2007 - the sale of Telecom's Yellow Pages to a private-equity consortium of CCMP Capital Asia and Teachers Private Capital, and the acquisition of TV3 owner MediaWorks by a subsidiary of Australian private-equity firm Ironbridge Capital.
Both buy-outs were launched in the first half of the year.
This year there have been no successful bids. Canada's pension fund tried to buy a stake in Auckland Airport but was blocked by the Government.
SkyCity Entertainment Group also invited bidders to have a look at its books in the second half of last year and private-equity player TPG Newbridge Capital with Apollo Management was said to be interested.
But no bid eventuated and in February it conceded all deals were off the table as the interested party could not get the funding together.
SkyCity's situation appears symptomatic of the top-end of the private-equity market.
At an estimated $2.3 billion, it would have required a consortium of international banks to back the debt funding for a private-equity player.
That's something most banks are no longer comfortable doing since the US credit crunch, says Tim Sims, a director of Australia's largest private-equity firm, Pacific Equity Partners, and a key player in the New Zealand market.
"For deals above a billion or a billion five you have always had to go offshore to a bigger pool of money than is immediately available from the local debt market.
"Those offshore sources have been distracted by the pricing and liquidity issues in the sub-prime market since mid-August last year." He says the last big deal to go ahead in Australasia after the sub-prime squeeze in August was the $2.7 billion buyout of Coates Hire in September.
"While there are signs that some of the large international lenders are returning to active duty there hasn't been anything over a billion in the local market since the Coates deal."
Funding of the sub-billion-dollar market is traditionally handled by in-market lending institutions. Here there have also been second-order effects flowing through from the international credit and risk pricing squeeze.
While not directly exposed to sub-prime in a meaningful way, Sims says Australian banks did have large credit positions in some companies that were credit hungry.
"They have seen their offshore funding costs increase and have seen some significant unexpected credit challenges emerge in companies whose business models were directly exposed to large-scale, offshore credit supply so they are naturally wary about the stresses and strains of the current environment."
Sims says this has tended to result in an informal prioritisation - banks will have a natural preference for demonstrated consistency and performance delivery, a strong credit history, large equity reserves and a commitment to an unwavering presence in the market. This means those that tick these boxes have access to as much debt as the deal can reasonably handle at the new high prices.
For private-equity players in general it all means access to debt has become more expensive and more selective. So to achieve their target returns private-equity players are more constrained in the prices they can offer vendors than they were in 2006-07. Ironically, lending margins are now similar to the ones in the 1998 to 2002 period when private equity was growing fast and building momentum in New Zealand and Australia.
Sims says it will take a little while for vendors to accept that the market is back to more normal levels, particularly if their business is bruised by the current trading environment.
The businesses being offered now are an interesting blend of smart vendors who accept the current conditions are here to stay and are keen to get their money out and take advantage of the high interest rates, and the reluctant vendors who need to address funding issues.
History proves that many vendors will wait it out, see their businesses decline, lose the opportunity to redeploy while cash is king and receive ordinary prices for the business after a long, frustrating delay.
Kerry McIntosh, NZ head of Ironbridge Capital, which bought MediaWorks in 2006, says: "With volatile financial markets vendors with assets have been sitting on their hands a bit. If you were a vendor of assets why would you choose now to sell it?"
But he believes as sellers adjust to the change some deals will come back again. "There has been a bit of a hiatus. But I think that is now changing - people are becoming more used to the conditions."
In Australia there have already been a few transactions in the middle of the market as highly leveraged business owners have been forced into distressed sales. But that has not happened in New Zealand.
"Australian entrepreneurs have put their entire savings into their businesses and then taken out margin calls on top of that. New Zealand entrepreneurs have not taken on the same level of personal leverage. That's a cultural difference." Some have suggested private-equity players themselves may be over-leveraged and if they were forced to sell most would not get the same price today for what they bought in 2006 or 2007.
But McIntosh says one of the advantages of being a private-equity investor is that a liquidity event such as public listing can be timed to suit the markets. He says private-equity investors are prepared to wait out the market turmoil and few would chose an environment like the current one to exit their investments.
Both Sims and McIntosh insist the rates of business failure are very slim for those invested in by private equity and tougher times will just mean private-equity players hang on to their businesses for longer.
But not all private-equity players are unhappy about the change in market conditions.
Ross George, managing director of New Zealand private-equity firm Direct Capital, which last year helped Ezibuy to buy out Max Fashions, says the past two years have been tough for smaller private-equity players because the valuations rose too quickly.
"We think during that time they probably rose 40 per cent. A lot of people just sat out at that level. Now it's probably back to normal."
For groups like his that don't use as much bank-funded debt there are now some good opportunities coming up.
"Banks have pulled back a little bit. We have equity - that situation is positive for us at the moment. The mid-market for us is about companies worth $30 million to $150 million. That market hasn't changed at all."
George says most New Zealand companies fit in to that price bracket and a baby-boomer bubble means many business owners will be looking to sell out in the next seven years.
"Most company owners in this size bracket are over 60 years of age. They are all thinking about selling their businesses. They are all creeping a year older each year. There is a big move to sell a bit earlier to avoid the rush or market flood.
"That is the single biggest area of private-company investment. That part of the market is probably growing at 20 per cent per year." George says it is also typical that the first half of the year is a slower time for private equity.
"There is never much happening at the start of the year. Most deals get done by Christmas then most go away for a holiday. By the time they get organised to sell, it's about now. The first half of the year is traditionally much quieter." He predicts it will pick up in the second half of the year.
But New Zealand venture-capital association executive director Colin McKinnon says its hard to tell what the second half of the year will be like.
"There is a notable absence of large transactions driven by the change in the credit environment. The first half of the year has been very quiet for that end of the market. However in the mid-range the banks are still keen on business. There are still transactions being done but of a more modest size. More in the $10 million to $30 million range."
He says the appetite of private-equity players and banks hasn't diminished in the mid-size market.
The slowdown has not stopped at least one new player from entering the market. Maui Capital, a group of private-equity specialists, has split from Goldman Sachs JB Were and raised $230 million in what is now the largest private-equity fund raised by a New Zealand player.
