Last year, Boston buyout firm Thomas H. Lee Partners snapped up a half-dozen businesses for a total of $65 billion. This year, the firm has made just one purchase, in January, for $5 billion.
"You can't afford to pay the same prices for companies that you paid in the early part of '07," said Scott Sperling, the firm's managing director. "So you just have to be patient and wait for prices to adjust."
The leveraged buyout binge, which pumped $650 billion into the US economy over the past 18 months, is giving way to an era of reduced activity for private-equity firms. Not only is the number of deals shrinking, but also buyout executives are canceling deals already signed and renegotiating others at marked-down prices.
The pullback began in the summer when banks responded to deepening problems in the subprime mortgage market by halting the flow of cheap credit. Without access to inexpensive debt, "the level of activity has dried up," said Josh Lerner, a Harvard Business School professor who warned that the buyout industry may be entering a retrenchment similar to that of the early 1990s. "Private equity is very sensitive to the amount of debt out there and the generosity of the terms."
Few places feel the squeeze more than Boston, one of the nation's largest private-equity centers. Boston's buyout giants such as THL Partners and Bain Capital have bought and sold dozens of brand-name companies over the past decade, among them Domino's Pizza, Burger King, Toys "R" Us, and Houghton Mifflin Co.
THL Partners currently owns franchiser Dunkin' Brands, the Simmons mattress company, and the Nielsen media rating firm, while Burlington Coat Factory and the American Standard bath and kitchen products maker are among the companies in Bain's portfolio.
A prolonged slump in the private-equity industry would pinch the small army of lawyers, accountants, consultants, investment bankers, and other specialists who serve as intermediaries for leveraged buyouts, Lerner said. But the impact on the broader economy would be less severe because the buyout firms invest worldwide and employ relatively small numbers of people at their Boston home offices.
Private-equity firms use funds raised from their investors - big-money institutions such as pension funds and university endowments - to help them borrow more from lenders to buy controlling stakes in companies. In a typical scenario, they will restructure a company and improve its performance, sometimes by purchasing or "rolling up" rivals, before reselling it for hefty profits five to seven years later.
Buyouts in the United States, which have surged since 2005, peaked in the second quarter of this year with 169 deals worth a record $200.2 billion, according to Thomson Financial data. The number of deals tumbled to 145 valued at $54.7 billion in the three months ending Sept. 30. So far in the fourth quarter, buyout firms have signed 80 deals valued at just over $5.8 billion, on pace for the smallest dollar outlay in four years.
As tighter credit has pushed up the cost of deals, many have fallen apart or been renegotiated at drastically lower prices. Seventeen leveraged buyout agreements worth a total of $96.6 billion have been withdrawn in the United States this year, according to data compiled for the Globe by the Thomson Financial research firm in New York. By comparison, just $11 billion worth of deals were withdrawn last year.
"The number of big deals that have not gotten done has increased dramatically," said Paul Edgerley, a managing director of Bain Capital in Boston, one of the largest private equity firms.
Some deals that have closed in the second half of the year have been revised at a steep discount from initial agreements, with buyout firms citing a tougher financial environment and threatening to back out if sellers don't settle for less. In one prominent example, Home Depot Inc. in August completed a sale of its construction supply division to a private-equity consortium led by Bain for $8.5 billion, nearly 18 percent less than the $10.3 billion the parties agreed to in June.
Tighter credit also could force buyout firms to hang on to companies longer in the hope of selling them for a high enough price to offset their higher deal costs, suggested Howard Anderson, professor at Massachusetts Institute of Technology's Sloan School of Management and a former venture capitalist.
"They're going to have to put up more money, stay in longer, and pay more for their debt, so returns are going down," he said.
Some critics of private equity, who argue its short-term focus displaces workers and starves research and development, view the slowdown as a welcome respite from the frenzied dealmaking.
"In the long term, the correction is probably healthy because too many of the deals materialized only because of the very low cost of borrowing money," said Alan Tonelson, research fellow at the US Business and Industry Council, a trade group for small and midsized manufacturers.
The mounting number of deal withdrawals has especially affected big transactions dependent on high-risk "junk bond" financing.
"What we're seeing is a pullback in the larger deals," said Dan Reid, who leads transaction advisory services for accounting firm Grant Thornton. "We're not seeing that as much in the middle market."
Last week, Cerberus Capital Management backed out of a $1 billion agreement to buy an H&R Block subsidiary, and last month it canceled a $7 billion deal to acquire United Rentals. Another top player, Kohlberg Kravis Roberts & Co., in September walked away from an $8 billion deal to purchase Harmon International. The terms of the deals vary, with intended buyers having to pay termination penalties in some cases and negotiating financing or due diligence "outs" in others.
Despite the credit crunch, buyout firms still have been able to raise money from limited partners eager to invest in deals with a potential for outsized returns.
THL Partners has just amassed a $10.1 billion fund, its largest ever, to invest in North American companies, while Blackstone Group LP, the world's largest buyout firm, raised a $21.7 billion fund in August. Many buyout executives are continuing to hunt for deals.
"Our activity has not slowed down," said Bruce R. Evans, managing partner at Summit Partners in Boston, which unlike its rivals makes investments using "minimal leverage," or bank debt.
Bain's Edgerley said his firm will benefit from its global reach in the next two quarters when good deal pricing will be harder to come by.
In addition to its US operations, Bain has been scouting for deals overseas where it can access cheaper debt from banks in places like Japan, China, and even Europe, making some deals more viable.
Robert Weisman can be reached at weisman@globe.com.
