If your company is in trouble because of the economic downturn, don'texpect a buyout firm to come to the rescue. Despite plunging stockprices this year -- or perhaps because of them -- buyout activity has beencut in half, and analysts don't expect it to improve until the economy showssome life.

Investments by buyout firms have slipped by about 50% this year tobetween $40 billion and $45 billion, according to Jesse Reyes, vice president ofVenture Economics. Meanwhile, total funds raised has fallen to around$47 billion, from $87 billion last year. Still, this remains the third-bestyear on record, and Reyes estimates that buyout firms are sitting on$60 billion to $75 billion of unspent capital.

"The capacity is there, but everyone is taking a vacation frominvesting," said Reyes. "They're worn out."

Getting Tight

One well-documented reason for the decline in buyout activity this yearhas been tightening credit markets. Banks have become more conservative over the past year, insisting that loans to buyout targets represent a much lower multiple of their cash flow. Banks are lending at 2 to 2.5 times cash flow instead of the historical rate of 3 to 3.5 times, according to Dan Friedberg, vice president of Bain & Co. The high-yield and mezzanine markets are equally tough.

"The credit crunch is absolutely real," Friedberg said. "Thewillingness and appetite for lending has come down."

Leveraged buyouts work like this: buyout firms purchase a company --usually a private one -- or take a controlling interest using asignificant amount of borrowed money. In the past, these companies couldmake acquisitions with as little as 20% to 25% equity, but stricterrequirements mean they must now put up about 40% equity, Friedberg said.

"If you have to put in more equity, you have to grow your top andbottom line a lot more quickly in order to generate the same returns," hesaid.

In addition to these structural changes, analysts say there is adisconnect right now between what buyers are willing to pay and whatsellers think their assets are worth.

Room to Fall

According to Reyes, some buyout firms are unwilling to acquirecompanies at this time because they believe prices could fall further.Although stocks have plunged, private valuations have not fallen asprecipitously, he said. And besides, lower prices don't necessarilytranslate into great buying opportunities. Although there are somepublic-to-private deals being considered this year, stock price declineshave been justified to some extent because of a correlating slide in salesand profitability, analysts say.

"You want to buy a company and sell it for a higher price, but there'sno guarantee that prices are going to go higher," said Reyes. "Buyoutfirms don't just want to acquire distressed companies, they want to get anincrease in value."

Buy and Hold

Unlike LBO buy-and-bust tactics of the 1980s, when companies werebought, broken up and sold off in parts, buyout firms now hope to addvalue to their acquired companies by improving profitability, strengtheningmanagement, and sometimes purchasing related businesses and combining thepieces.

Another reason that buyout firms may be shying away from makingacquisitions is that recent investments, especially those in the telecomsector, have become disasters. Several major buyout firmspoured millions of dollars into these companies in the late 1990s. HicksMuse Tate & Furst, Welsh Carson Anderson & Stowe, and Kohlberg KravisRoberts & Co. are among those that have seen investments sour.

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"They got burned with the telecom boom in 1999; now it's back tobasics," said Mario Giannini, president of Hamilton Lane Advisors.

Indeed, the largest deals this year have been done in the consumer, financial services and health areas. Hicks Muse tops thelist of active players with six deals this year, compared with 21 deals lastyear. Others include Heartland Industrial Partners, Oak Tree CapitalManagement, Hellman and Friedman, Welsh Carson and Apollo. However,activity has slowed dramatically, "and they're now doing deals in hundredsof millions rather than billions," Reyes said.

Even if buyout firms were willing to go on an acquisition spree, somesellers are not so eager to let go of their businesses at a time whenprices are perceived to be low. Many companies still remember thevaluations they were receiving two years ago, and they hope to see suchvaluations again when the economy rebounds. If they can go it alone, it'sunlikely that they will dilute their ownership at this time.

"The deals that have been done this year are deals that had to bedone," Friedberg said. "And because those companies had to be on themarket, they were less attractive."


( MCLD), a local exchange carrier, was a company that desperatelyneeded help, having seen its stock fall 99% from last March to 36 cents.Forstmann Little agreed last week to eliminate at least 95% of thecompany's $2.9 billion of bond debt and the associated $300 million ofannual interest expense. Forstmann also agreed to infuse $400 million intotroubled telecom, voice, and data services provider



. That company has also seen its stock fall 99% since lastMarch.

Needing Easing

For the private equity business to get back on track, analysts say thecredit markets need to ease up and banks need to start lending more freelyagain. Meanwhile, buyers and sellers must agree on fair valuations. Butthose developments will only come about with an improvement in the economicoutlook.

"You need to be able to value companies based on future cash flow,"Friedberg said. "But uncertainty impacts the whole equation; there's noclarity on business prospects over the next six months."

If and when the economy does recover, analysts say the mostdesirable buyout candidates will be those with steady, predictablebusinesses. Those with more shaky business models -- the ones perhaps most inneed of rescuing -- are much less likely to be bailed out.

"There's been a shift out of technology into old-line manufacturing,"said Giannini. "But right now everyone's waiting to see when the recoverywill come."