Private equity firms are flexing their muscle this year like never before, and that's good news for Wall Street investment houses faced with a stock market that's having a hard time gaining traction.The importance of private equity to Wall Street was on display Monday with the $33 billion leveraged buyout of HCA ( HCA), the Nashville, Tenn.-based hospital chain. Along with the enormous fees the deal is generating for a slew of investment banks, one Wall Street firm, Merrill Lynch ( MER), stands to also benefit as a principal in the transaction. Merrill Lynch, along with well-known private equity firms Bain Capital and Kohlberg Kravitz Roberts, are the big-money investors agreeing to buy HCA for $51 a share, an 18% premium to HCA's price before news of the talks emerged last week. The deal calls for the trio to pony up about $6 billion, while raising $15 billion in bank loans and bonds. The deal includes HCA's $11.7 billion in assumed debt. Look for Merrill Lynch and other investment banks to do their best to keep the go-go market for private equity humming. It's the kind of high-margin business Wall Street needs in an increasingly stagnant market. "The private equity market has definitely taken off, and these big deals are becoming more common," says Matthew Rhodes-Kropf, a professor at Columbia University's business school. In fact, the total dollar value of buyouts this year has surpassed last year's record-setting figure, according to Dealogic. Private equity firms usually make money by buying a company and cutting costs or reforming the business over a number of years. Depending on the investment, the private equity firm often will pay itself a dividend each year for its work, then sell the restructured business for more than the purchase price.
For Merrill Lynch, taking a starring role in a private equity deal is becoming a regular occurrence. In the second quarter, Merrill Lynch took in an estimated $700 million in revenue from private equity transactions, which market sources say came mostly from its past investments in rental-car company Hertz and retailer Debenhams. This year, Merrill Lynch has been on such a roll that its second-quarter private equity revenue far surpassed the estimated $354 million that Goldman Sachs ( GS) reportedly took in during the same period. That feat earned Merrill Lynch some well-earned bragging rights on Wall Street, given Goldman Sachs' reputation as a perennial private equity titan. In the HCA transaction alone, Merrill Lynch acted as a jack-of-all-trades. As an adviser to its own private equity group, Merrill Lynch will earn an estimated $13 million in fees, according to data from Thomson Financial. Depending on the firm's financing role, it could also rake in north of $60 million for financing debt for the deal, according to other market sources. But nothing compares with the windfall Merrill Lynch is hoping to make from the private equity side of its dealings with HCA. In this instance, Merrill Lynch invested a reported $1 billion of its own cash in HCA. A back-of-the-envelope analysis by an investment banker who is not party to the deal suggests Merrill could make at least $1.5 billion over the next five years on HCA, on top of recouping its $1 billion initial investment in an eventual initial public offering. The figure is based on a 20% return, a somewhat conservative return on this type of investment, and assuming the firm holds HCA in its portfolio for the next five years. The HCA investment is the kind of high-profile move Merrill Lynch has taken in recent years to broaden its revenue stream beyond conventional investment banking and brokerage. E. Stanley O'Neal, Merrill's chairman and CEO, has gotten the firm back into energy trading, and he's expanded Merrill Lynch's home-mortgage lending business. Of course, Merrill Lynch isn't alone on Wall Street in moving into private equity.