Will the PE-backed stampede in entertainment and media rebound?


Once upon a time, names like Providence, Blackstone, Carlyle and KKR were familiar to Wall Streeters only.

Then a bull run of buyouts of entertainment companies, in both the U.S. and Europe, turned a dozen private equity players into household names in Hollywood and beyond.

But an increase in deal multiples financed by the cheap debt that investment banks have made available by the billions has caused private equity investors and banks to become skittish. That, coupled with both the ongoing turmoil in the high-risk subprime mortgage space and this summer's global credit crunch, has brought the flow of PE-led buyouts in the media and entertainment field to an abrupt halt.

Deals are expected to resurface in 2008, but a broad survey of insiders suggests things will never be quite the same both in terms of deal size and buyout targets.

"The way we knew things for the past year is gone," says Neil Begley, media and entertainment analyst at Moody's Investors Service. "Very heavily debt-laden deals with little protection" for debt holders have run their course.

"There will be fewer debt-driven deals," explains Hal Vogel, president of Vogel Capital Management and a longtime entertainment analyst. "And it may be hard to find big companies outside maybe cable or newspaper or book publishing that would want to go private."

The big buyouts

The past three years have seen an unprecedented wave of big-ticket, private-equity-backed deals in the entertainment biz.

In 2004, a group led by Edgar Bronfman Jr. and Thomas H. Lee Partners, but also including Bain Capital and Providence, acquired Warner Music for $2.6 billion. It was one of the first major sector buyouts of the recent run, and the price amounted to a deal multiple of more than nine times earnings before interest, taxes, depreciation and amortization (EBITDA).

In another key deal, the media measurement and information firm now known as the Nielsen Co., parent company of The Hollywood Reporter, accepted a $10.3 billion offer from a buyout group that included Blackstone, Carlyle, Hellman & Friedman, KKR, THL and AlpInvest. That meant a multiple of 13.4 times EBITDA.

And earlier this year, investors including Madison Dearborn, Providence, Texas Pacific, THL and Saban Capital completed the acquisition of Spanish-language media giant Univision for $12.3 billion plus $1.4 billion in debt. This valuation meant buyers paid a multiple of 14 times EBITDA.

The slew of big entertainment LBOs culminated with Terra Firma's recent $4.7 billion buyout of music major EMI, which translated into a multiple of more than 18 times EBITDA.

CHART: Binge and merge
High deal multiples and this summer's credit crunch has slowed the recent bull run of private-equity-backed M&A activity in the media and entertainment space. A look at some of the largest private acquisitions in the sector announced in 2006 and 2007 (through October.)
View chart

Those kind of multiples put significant pressure on companies because the debt leverage heaped on them cuts into EBITDA margins, leaving little financial flexibility, especially in the now-weakened credit market.

Plus, some, such as Warner Music, ended up paying their private equity owners dividends, which allows owners to recoup their investments faster but further strains a company's flexibility.

Standard & Poor's credit analyst Deborah Kinzer recently identified the 13 most vulnerable media firms that have the highest risk of liquidity problems, including Univision and smaller TV station groups Nexstar and Gray Television.

"The buyouts have put these companies in very weak financial positions," she pointed out in a report. "As a result, these issuers face declining EBITDA margins, and many of them have difficulty achieving positive discretionary cash flow."

The credit squeeze of recent months suggests that debt will become more expensive and come under more restrictions, making big deals -- especially those beyond the $10 billion range -- especially difficult.

"PE hasn't gone away," says Lawrence Haverty, portfolio manager at Gamco Investors, "but we are in a transition." Once investors weather the crunch, "deal multiples will be lower, and there will be less debt leverage" in media and entertainment buyouts, he predicts.

"Private equity is still flush with capital to invest, but the trick will be how to generate the same returns and over what time horizon this will happen," says James Hudak, senior managing director and group head at finance firm CIT Communications, Media & Entertainment.

Overall, this will mean that PE firms will have to be "more choosy about transactions, because they will need to put in more of their own equity and risk," Moody's Begley predicts.

Irrational deals?

As one of Wall Street's biggest PE players, THL has been involved in such major media deals as Univision, Nielsen and Clear Channel. But co-president Scott Sperling says the credit squeeze makes a fast return of such major buyouts unlikely.

"You couldn't do these kinds of big deals in the current market," Sperling says. "The price tag of buyouts -- including in the media and entertainment space -- earlier this year started becoming excessive," with multiples often several points above what many believe could have been expected.

One entertainment industry example that several sources pointed to is the acquisition of EMI by Terra Firma.

"The crash in the credit markets came because we saw a willingness to pay high valuations supported by high debt levels that weren't rational," Sperling explains, adding that he feels THL remained prudent.

Other industry watchers believe the PE boom led to some buyouts being driven by "irrational exuberance" -- former Federal Reserve Board chairman Alan Greenspan's oft-repeated phrase describing the overvalued stock market during the late 1990s. This summer's credit squeeze led to the scrapping of several industry auctions, including that of U.K. cabler Virgin Media and the planned sale of small U.S. cable operator Insight.

In these deals, sellers realized that PE firms suddenly didn't have access to the same cheap debt.

A recovery timeline?

In recent weeks, debt-driven deals in various industries have started moving, a sign that clouds over the debt markets are starting to lift.

Sperling expects a rebound in buyout activity across sectors including media and entertainment some time in 2008. But Vogel is slightly more pessimistic, believing activity won't pick up until late '08 at the earliest. Even then, "the prices will be below the peak multiples seen earlier this year."

But first, there's a backlog of previously struck but not yet completed deals driven by PE firms that has to be worked off before new deals can start rolling. James Attwood, managing director and head of the global telecom and media group at Carlyle, predicts it could take until the end of the first quarter of next year to move all the backlogged PE deals forward.

Standard & Poor's estimated last month that investment banks were planning to bring to market around $187 billion in risky loans to finance previously announced buyouts across all industries. Including junk bonds, around $300 million still has to move through the deal pipeline.

To chip away at that number, banks can either sell the debt or loans or cancel a planned buyout deal. Some banks have started writing down a portion of their promised financing. That number could end up being about 10% of announced deals, which is sure to make banks more careful when promising future buyout financing.

Still a draw

However long a rebound may take, PE executives with a media and entertainment focus say they will remain active in acquisitions due to the strong cash flows of sector companies.

TV and radio stations are one area many observers say will remain attractive, with some also listing cable operators, publishing assets and new media assets.

German broadcaster ProSiebenSat.1, Clear Channel and Clear Channel's TV group are among the various examples of broadcast assets that have fallen into PE hands in recent years.

But CIT's Hudak thinks the changing debt markets could cause a shift in the kind of companies targeted by private-equity consortia.

"PE was able to get away with investing in companies that generated stable cash flows but showed low growth -- but still, the PE fund achieved a great return," he says. "This is going to be much harder over the next year or two as the debt markets will not tolerate as much leverage or the payment of as many dividends. It will force PE to seek out the real growth companies."

Attwood and Hudak agree that the PE focus could shift into different areas -- Internet, digital media and online advertising to name a few.

"The media and entertainment industry is still in the early stages of digital transformation," explains Steve Abraham, global leader, media/entertainment industry, for IBM Global Business Services. "Many new companies are staking out turf throughout the value chain of production and distribution with many areas of focus -- infrastructure, technology, applications, services, creative. And many of these upstarts will attract PE money."

More mergers?

While some argue that the industry has seen enough consolidation in recent years that there is little room for megamergers, others say that that actually creates new opportunity in cases where media giants sell non-core assets.

PE firms could, for example, play a role in News Corp.'s recently earmarked sale of Fox TV stations and its billboard unit in Eastern Europe. Similarly, Time Warner could decide to sell its Time Inc. and AOL divisions, with PE players likely at least to take a long look.

The digital transformation of the media economy also plays into the hands of PE players.

"The entertainment industry has gone through so much change over the last four to five years, and this will continue," predicts former Time Warner and Viacom CFO Rich Bressler, who is now a managing director at THL. "That uncertainty is what creates the opportunities for us."

Despite this uncertainty, relatively predictable cash flows have made media and entertainment firms particularly attractive to PE folks, and many expect this won't change.

"Companies focused on subscription-based models and ad models will continue to be popular, because PE groups use leverage, so they want to have predictability," suggests Emily Burg, director of strategy at Growthink, an investment banking services firm for such clients as Paramount and digital cinema innovator DCIP.

A level field?

According to many observers, the recent credit crunch could depress company valuations and level the financial playing field for strategic buyers -- media and entertainment companies looking to acquire peers.

"(Strategic buyers) haven't been as willing as PE groups to pay up" for media and entertainment properties, says Begley. "Over the last year or two, they haven't been able to compete for deals at all."

And if anyone has doubts about PE's commitment to the media and entertainment industry, Sperling has some clear words on where THL stands: "We have been one of the most active private equity groups in media and have a lot of experience. And it is an area that we'll continue to have as one of our core focus areas."  

ON THE MONEY: On Nov. 7-8, the Nielsen Co., parent of The Hollywood Reporter, will join with Dow Jones to present the Media and Money conference at the Grand Hyatt in New York. The event will include discussions with some of media and entertainment's top dealmakers and investors, including Viacom chair Sumner Redstone; Time Warner president and COO Jeffrey Bewkes; Michael Eisner of the Tornate Co.; Roy Salter of the Salter Group; Daniel Snyder, owner of the Washington Redskins; Michael Lynne, co-CEO of New Line Cinema; Relativity Media CEO Ryan Kavanaugh; Chip Seelig, managing director of Dune Capital; Norman Pearlstein of the Carlyle Group; Columbia Pictures COO Bob Osher; and Jeff Berg, chairman and CEO of ICM, as well as panels moderated by THR executive editor Paula Parisi and New York bureau chief and business editor Georg Szalai. For more information, visit mediaandmoneyconference.com