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Market Overview

• The acquisition of privately held companies by private equity groups (PEGs) totaled $28 billion in Q2 with 373 completed deals, a slight drop from the 438 deals totaling $32 billion in Q1, according to data tracked by PitchBook.
• With $69 billion in total sales for the first half of 2011, the sale of privately held companies by PEGs set a record for the best six-month period.
• In terms of transactions, the two most popular regions continue to be the Midwest and the Southeast, at 20 percent and 17 percent of total transactions, respectively.
• Increasing deal activity is anticipated for the second half of 2011 as private equity firms invest their $466 billion of dry powder.

Total Private Equity Deal Flow

Given the economic uncertainty that overshadowed Q2, a drop in deal activity isn’t surprising – and perhaps we should be relieved that it wasn’t greater.

As we enter Q4, the direction of the global and U.S. economies remains unclear. In Europe, the debt crisis persists, while the Middle East faces constant political upheaval and unrest. Here at home, Washington still finds itself in a political gridlock, and gas prices are above the year-ago average for the 81st consecutive week, as indicated by API data published Sept. 28. In addition to – and as a result of – the shaky state of affairs, the Consumer Confidence Index plummeted to 44.5 in August (its lowest point in two years), and it remained essentially unchanged in September, according to the Consumer Confidence Board. When the economy is cloudy with no sign of improvement on the horizon, we expect that deal activity might suffer – such was the case in Q2.

Calm Persists After Active Q4

Deal volume continued to ease up during Q2 following the spike in Q4 of 2010. According to PitchBook, a private equity research firm, total transactions for Q2 were comparable to the previous quarter, dropping slightly by 14.8 percent (373 deals reported in Q2 versus 438 deals reported in Q1). Since the low of Q2 2009, private equity activity has seen an average of 400 deals and $30 billion of investments per quarter; Q2 2011 remains relatively in-line with these post-financial crisis levels.

Deal Activity Focused on Smaller Deal Class Sizes

In the first half of 2011, deals under $500 million accounted for 87 percent of total transactions, according to PitchBook data. Of the 211 deals completed in the same six-month period, 85 were completed in the under-$50 million category, and 75 were completed in the $50 to $250 million category. Though smaller companies still are seeing more transactions, mega-deals (more than $2.5 billion) are reappearing: Six were completed in 2011 YTD, compared with the eight that were done in all of 2010. Additionally, it’s the larger deal class sizes (more than $500 million) that are seeing the majority of capital investment.

Exit Activity Remains Strong

 In Q2, 105 completed exits were reported by PitchBook, which is consistent with the 108 reported in Q1. Completed exits for the two quarters combined totaled $69.27 billion. Of the companies sold during the first half of 2011, 63 percent were corporate acquisitions, while 29 percent were secondary transactions and only 8 percent were IPOs. Expectations are high for upcoming quarters due to large company inventory in private equity portfolios, cash availability and a recovering IPO market.

On the Horizon

The Good: Still lots of money on the sidelines and private equity managers are eager to complete acquisitions. Additionally, banks are seeing increased loan demand and rates remain at historic lows.

The Bad: At least in the lower-middle market, we expect to see valuations remain compressed for some period as the economy remains in slow growth mode.