Grip of PE firms seen loosening

Credit crunch puts strategic buyers back in the game

For a case study in how the recent global debt market crunch could affect media and entertainment deals, look no further than the multibillion- dollar auction of U.K. cable TV group Virgin Media.

Initial bids originally were due next week, but amid the market conditions there have been financing difficulties for the private- equity groups that in recent years have often won out over industry players — what Wall Street calls "strategic buyers." That has led to a delay in the Virgin Media auction, the Financial Times reported Thursday.

According to Wall Street talk, private-equity giant Blackstone Group Lp. is considering dropping out of the consortium eyeing Virgin as it sees little return on a deal.

As they generally rely on deals that use a lot of debt leverage rather than cash and equity — hence the term "leveraged buyout" — private-equity firms are facing more of an uphill battle because of the crunch.

"Privateequity firms have to step up with a greater equity check or put deals on hold until the market rebounds," GE Capital Markets managing director Ed Ribaudo said.

At the same time, potential strategic buyers — from John Malone's Liberty Global to Comcast Corp. and Time Warner Cable — are believed to have fairly good chances should they decide to bid for Richard Branson's Virgin.

Many sector biggies are in a solid position for future deal opportunities given that many of them have refinanced debt at better terms and cleaned up their balance sheets in recent years, observers noted.

"The crunch clearly strengthens strategic players" even though it doesn't eliminate private-equity bidders, said Lawrence Haverty, portfolio manager at Gamco Investors.

Ribaudo also said that private-equity firms have bid up stock multiples, meaning their weakening could bring down valuations and thereby "make them more reachable for strategic buyers." However, he also warned that the buyers' own weakened stock price means that strategic players might not as easily use shares as acquisition currency.

What this shift in the balance of power will mean for overall dealmaking momentum remains a subject of debate.

The crunch is likely to slow media and entertainment deal momentum in many markets, some said.

"It's not a showstopper, but it is not as easy to pull off deals, especially big ones, as it used to be two or three months ago, and the trend is toward a further tightening of the credit market," Hal Vogel, president of Vogel Capital Management and a longtime media and entertainment analyst, said in discussing the U.S. market.

"Nothing has happened over the past week that changes the business fundamentals" on the media industry, Haverty said. "I'm not pessimistic for deals." He does, however, predict that deals will be less aggressively relying on leverage in the future, which in itself could foil some deals.

In parts of Europe, analysts already predict a reduction in M&A fever. The region has seen several mega-deals this year, including ProSiebenSat.1's planned $4.5 billion buyout of SBS Broadcasting and Mediaset's $4.6 billion acquisition of production giant Endemol.

"We are already seeing interest cool, and a lot of mergers that had been on the radar for a month from now are listed as for three months from now" because of financing delays, said Javier Noriega, chief economist at Milan investment firm Hildebrandt and Ferrar. "And it's possible the situation will get worse."

Italy is another key media market that could bear the brunt of a deal slowdown. The country has been bubbling with buyout deals, with Mediaset acquiring film distributor Medusa in addition to Endemol and DeAgostini's snatching up France's Marathon TV, Italy TV production house Magnolia and film distributor Mikado.

"In Italy, the impact could potentially be greater because so many deals here use leverage and cascading ownership structures," said an Italian acquisitions exec at one of the country's leading media groups.

Meanwhile, the tightening of international credit likely will have little effect on the wave of consolidation in Germany's cable TV market, market watchers said.

Luxembourg cable group Escaline, having secured low-cost financing for its takeover deal of German cable company PrimaCom, said that for the company, the tightening is not an issue. "If it comes to a real crunch there could be a project realignment, but there won't be a strategic realignment in our consolidation plans for the German cable market," a spokesman for Escaline German unit Orion Cable said.

Some even said the debt market woes could speed up Teutonic cable consolidation if smaller regional players find it harder to refinance debt and are forced to sell assets.

As of late, some major private-equity deals have run into trouble. A team of Goldman Sachs analysts in a report last week cited such examples as DaimlerChrysler, U.S. Foodservice and ServiceMaster.

As a result, some have questioned whether previously announced private-equity deals for media and entertainment firms will be pulled off, but so far they appear to still be on track.

Shares of Tribune Co. have been trading well below the $34 per share (or $8.2 billion) price tag promised by private equity-backed real estate maestro Sam Zell, with analysts saying that is a sign that the credit market woes could doom the deal, even though Zell has not suggested such a scenario.

Similarly, given ProSiebenSat.1's strong cash flow, its heavily leveraged deal to acquire SBS is unlikely to be directly threatened.

"However, general economic turmoil or increasing interest rates may tighten things for the ProSiebenSat.1 group," said one senior German financial analyst. "I fear that SBS, for instance, has taken its forecast on expansion in Eastern Europe to the limit and has not taken enough precaution to balance negative effects."

If the credit markets recover over the mid-term, some believe that strategic industry buyers could end up selling recently acquired media assets to then-rebounding private-equity groups.

Miller Tabak + Co. analyst David Joyce said this could happen if Liberty Global ends up buying Virgin Media. Such a deal could be seen "as a flip within a few years when credit markets could more easily fund a private-equity buyout of Virgin Media," Joyce said.

Scott Roxborough reported from Cologne, Germany. Georg Szalai reported from New York. Eric J. Lyman in Rome and Dieter Brockmeyer in Frankfurt, Germany, contributed to this report.
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