Whither the Great Merger Wave?

The greatest ever merger wave is changing shape—but it may not be breaking yet.

“It’s a bump in the road, but not an unhealthy one,” says David Rubenstein. The morning after paying $21.3m for a copy of the Magna Carta dating from 1297, the boss of the Carlyle Group, a big private-equity firm, is in the mood to take the long view. The golden era of private equity is probably over, he concedes. “After a great ride for five years, private equity is entering a more challenging period,” he predicts. Returns are likely to come down, if only because they have been so high, he says. But the industry has been through downturns before, and each time “changes were made and private equity came back stronger.”

The future of the merger wave that has been sweeping all before it since 2003 now depends on how deep the downturn in private equity proves to be and how long it takes to recover and come back stronger. In the first half of 2007 deal activity was so rapid that last year was still the best ever for merger activity, according to Dealogic. But when credit started to crunch in the summer, activity slowed dramatically, particularly by private-equity buyers, which in the second quarter of 2007 accounted for an unprecedented one-quarter of all deals.

Almost overnight, instead of breaking new records every other week for the biggest ever private-equity acquisition, the scramble was to complete deals that had already been agreed on. Hard-pressed banks found themselves unable to syndicate private-equity debt and switched from practically giving away credit to supplying it at a high price, with strings attached, if they supplied it at all. Several high-profile deals fell apart, including some from blue-chip private-equity firms—a trend that has continued into the new year. A few minutes into January 1st PHH, a mortgage company, announced the collapse of its $1.8 billion sale to a consortium led by Blackstone Group.

Many of the wiser heads in private equity quietly admit that, thanks to easy credit, white-hot prices were paid by an industry that tends to do its best deals in cooler markets. Growing fears that the credit crunch will be followed by a recession, at least in America, have added to concerns about the quality of firms in many private-equity portfolios. During the recession of 1991-92 that followed the first boom in private-equity deals—which were known at the time as leveraged buy-outs—many of the firms that had been bought at the top of the market ended up in bankruptcy, unable to finance all the debt that had been used to buy them.

So far, defaults on corporate debt remain at record lows, though market prices predict this will change. But Mr Rubenstein is not alone in thinking that private-equity firms are “much better prepared for a slowdown” than they were. For one thing, deals have generally involved less leverage than they did in the 1980s. And the terms on which debt was raised mean that the banks are less able to force private-equity borrowers into bankruptcy.

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