No Big Deal

The credit crunch may have knocked the blockbuster out of favor, but middle-market M&A remains quite healthy.

When Citrix Systems Inc. announced its $500 million deal to buy XenSource Inc. in August, it seemed to be bucking a trend.

By most accounts, the merger-and-acquisition market had turned ice cold. After a superheated first half in which total North American deal values hit $1 trillion at the end of June, the subprime lending scandal suddenly dried up credit markets. The pace of M&A plunged from its weekly average of well over $50 billion; by the last week of August, not a single $2 billion deal had been announced.

But Citrix finance chief David Henshall wasn’t deterred in his push to make his company a bigger player in desktop and server virtualization-software markets, which have doubled in each of the past two years. By buying XenSource, Citrix became the only vendor offering both datacenter and desktop virtualization software — and gained sharply on industry leader EMC Corp.

“It’s an early, emerging market. We want to quickly become the number-two player,” says Henshall. “When companies see a deal as highly strategic,” he says, “short-term financial metrics tend to take a backseat to strategic importance.”

A closer look at the deal numbers bears out that assessment. Despite the precipitous drop in blockbuster M&A and the near-disappearance of big private-equity buyers, middle-market deals show surprising strength. And if only one or two proposals worth $2 billion are now reported each week, transactions below that level have continued at a rate of just under 40 a week (see “Stronger in the Middle” at the end of this article).

Strategic acquirers in particular have continued to find and close attractive deals. “Strategic deals are less affected by the turbulent market, and more are proceeding on schedule,” says Matthew Spain, managing director with UBS AG.

Cash Remains King

While private-equity buyers often depend on leveraged buyouts or complex syndications, midmarket strategic acquirers tend toward simpler, all-cash deals about 56 percent of the time, according to FactSet MergerStat LLC, which tracks global dealmaking. Some recent midmarket transactions have involved companies blessed with healthy cash positions or that prepared for deals by arranging for good financing terms. And stock-for-stock mergers remain an option.

“Strategic acquirers will clearly have an easier time than financial buyers in getting bank backing,” says Bob Hotz, cochair of Houlihan Lokey and co-head of its corporate finance group. Companies can support their midmarket deals with evidence of revenue and cost synergies, he says, while financial buyers often can point only to anticipated cash-flow increases from the combined properties.

Midsize companies are also nimbler in adjusting to market conditions. In August, Darden Restaurants Inc., owner of Olive Garden, Red Lobster, and other chains, planned to buy Rare Hospitality International Inc., operator of LongHorn Steakhouse, for $1.4 billion in cash. By obtaining a $1.2 billion senior interim and $700 million senior revolving credit facility, says CFO Brad Richmond, “Darden had its interim financing in advance of the volatile market situation, which we anticipated to some degree.”

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