To explore the impact of the 2012 presidential election on middlemarket dealmaking, Mergers & Acquisitions convened a special roundtable, held at the Nasdaq exchange and sponsored by Fifth Street Finance Corp. (Nasdaq: FSC) and Rutan & Tucker LLP. Participants included four private equity investors, two members of government (a Democrat and a Republican), two lenders, an investment banker, an attorney and a consultant. Most of the roundtable participants are supporting former Governor Mitt Romney (R-Mass.) in the election, which underscores the Bain Capital co-founder's popularity among his private equity peers. Watch our video interviews with the roundtable participants. And, for more coverage on the impact of the 2012 presidential election on middlemarket dealmaking, see our October cover story "Friends of Mitt," as well as "President Obama Has Friends in Private Equity, Too," and "Welcome Wagon for Small Businesses?"
Mary Kathleen Flynn, Mergers & Acquisitions (moderator): What's at stake for the middle market in the presidential election?
Leonard Tannenbaum, Fifth Street Finance Corp. (sponsor): The next president has a great challenge. The challenge coming up is in dealing with a year in which $1trillion dollars has to be cut from the federal budget. Both sides agree. There definitely has to be $1 trillion of entitlement cuts. The "Grand Compromise" will happen in the first quarter of next year. The Democrat and Republican senators that we have met in Washington both agree nothing is going to happen this year. Something is going to be mandated, but it's going to be next year. You have a whole landscape of uncertainty that the new president, or the existing president, is going to face. Will taxes go up? Will dividends go up? Will capital gains go up? Will "ObamaCare" get repealed? As I've canvassed small businesses across the state of Connecticut, I've found higher healthcare costs are the number one, two and three things concerning them. I've been talking to the 60 or 70 private equity sponsors that we lend to about their portfolio companies, and this is a big issue. So, the question is: Does healthcare get repealed? How do you forecast your business, how do you forecast what you want to do, and how do you think about deals and lending? This environment creates great uncertainty. The country is also going to make a choice between what I call statist and capitalist, not Democrat and Republican. This is a statist president. This is a president who wants a bigger, better government. And I personally don't believe in a big government. I believe in letting the markets work. Romney clearly decided that capitalism and free markets are much more his style. He doesn't want big government. He doesn't think the government is the solution to our country's problems. I just turned 41, and in my voting life, this is the most important election by far.
Flynn: How might Mitt Romney's experience as a private equity investor be relevant if he becomes the next U.S. president?
Geoffrey Rehnert, Audax Group: I consider Mitt a mentor. I worked closely with him throughout the entire time he was at Bain Capital. I was actually one of the two first associates, and so for the first five or six years of Bain Capital, there were really only a handful of us. So, I know the person he is. I know his ideology. I know his belief system. Mitt is a strong believer in capitalism and a strong believer in markets. And he's lived that, certainly, in his business career. I believe Mitt's experiences-15 years in private equity, another 10 years of business experience prior to that with Bain Capital, being governor of Massachusetts and a variety of other public-service undertakings-will serve him well if he gets elected in November. I've never met a more capable person in my lifetime. He has a tremendous intellectual capacity. He has an enormous energy level. He's very good at bringing people together and inspiring them and getting them to work hard to a common purpose. I believe the economic problems that the country faces are solvable. We have the fundamentals for a terrific economy in this country. And we had a terrific economy for a long period of time, and then we had a liquidity crisis in 2008. And that liquidity crisis was a mix of the subprime mortgage crisis and the derivative trading that was not understood by the financial institutions that were trading. And that liquidity crisis brought the global economy to a screeching halt. And then there was a change of administration, and although there has been a bit of a recovery, it's been a slow recovery. And it's been pretty much economic stagnation in this country and certainly throughout Europe for the last three or four years. I believe a different set of policies with a different leadership team in Washington will lead to a very different economic environment in this country, and that will ultimately filter throughout the globe. I think in my lifetime, it's probably the clearest choice going in one direction or another: statism versus capitalism and socialism versus free markets. In Europe, they're making the choice for statism, and it's become much more statist in the last three or four years. The question is: will this country follow that path, or will it return to the path we were on in the late '80s, '90s and the first part of this century?
Flynn: What's the perspective of the Democrats?
State Senator Bob Duff (D-Conn.): If you look back four years ago, the whole issue from our government's standpoint was trying to prevent us from falling off a cliff and prevent us from going into a depression. We know we had tough economic times, not just in the federal government, but in state governments as well. We went from record surpluses to record deficits. So, everybody was hurting, and unemployment was high. I think this election really is about growth, rather than four years ago, when it was about not falling off the cliff. This election is about: How can we grow our economy? How can we improve ourselves over the next few years? I don't know Mitt Romney. I don't really know Barack Obama, although I've met him a few times. I know both of them are smart. And I'm not going to demonize either one of them. I will say that the issue, in my opinion, is how we move forward. It's not so much the president of the United States. It is really the Congress of the United States, because, although the president is in charge of the day-to-day management over the executive branch, you really have the Congress that is putting forward the policy of the United States. Many of you are keenly aware of Dodd-Frank and whether you like it or you don't like it. There are probably parts of it I like and parts of it I don't like. But if you're going to say what is going to affect you all on a daily basis, it's really more what was negotiated in the halls of Congress, rather than what Barack Obama or Mitt Romney is going to do every single day. The other issue really is dysfunction versus the uncertainty. I think that markets will move much better when there's less uncertainty about what's going to happen. So, we're all going to say we support the Simpson-Bowles Commission, and, theoretically, I do. I think that it sounds like a decent compromise. It's a good mix. We know there needs to be some revenue. There needs to be some cuts, but let's try to find a way forward on doing that. One way or another is not going to work. There needs to be a combination of things. I believe the markets would respond much better if Congress would take a vote on Simpson-Bowles rather than saying, nothing is going to get done. We don't know what's going to happen until next year. We're not sure what's going to happen with the Bush tax cuts. We're not sure what's going to happen with Defense. As a real-world example, in my district, we have a subsidiary of Northrop Grumman called Norden Systems, which has been there for over 50 or 60 years, since World War II. Now they have pulled out, and we've lost 300 jobs. And the reason, in my opinion, is because of the deficit-ceiling compromise that was made that talked about the trillion dollars' worth of cuts in Defense. So, we're living that right now. And that's the uncertainty that's out there. To me, that is the biggest issue.
Flynn: If you have the ear of the next president, what will you urge them to do about middle-market dealmaking and private equity?
Russ Gerson, Gerson Group: Whether Obama is re-elected, or Romney is elected, the next president has to be more business-friendly. He has to provide an environment that is more encouraging to business, because growth is going to come primarily from the private sector. My sense is that if Obama is re-elected, the rhetoric will be toned down a little bit. "ObamaCare" is not going to get repealed, and Dodd-Frank is not going to get repealed, but there is probably going to be a slightly more business-friendly environment. I think Obama is running on this populist message, and I think that will tone down. When we advised Senator John McCain (R-Ariz.) on transition planning in 2008, he was going to have a very private sector-focused administration if he had been elected president. Top positions were going to be led by people that came from the private sector. My sense is that Romney is going to do the same thing. If Romney is elected, you're going to have an environment that's less regulated. You're going to have an environment that's more pro-business. You're going to have an environment that's more growth-centered. The reality is that Congress, at the end of the day, passes laws, but the president leads. As it gets closer to the election, the issues will be framed. And the electorate is going to be aware of the fundamental choice between the two different directions in which Romney and Obama want to take the country. And if Romney wins, he's going to have a lot of support from Congress. He's going to be able to lead Congress. And he's going to be able to persuade them, to a great extent, to achieve his agenda.
Gretchen Perkins, Huron Capital Partners: I would ask whoever the next president is to construct an environment of collaboration and urgency in Washington. Most of the country is very tired of inaction. It doesn't matter whether we call it an inability to get things done, or dysfunction. It's all the same result, which is not solving our problems, and they are solvable. Not everyone is going to get everything that you want in a compromise. But I think the next president, whether it's Obama or Romney, needs to firmly establish an environment and an intolerance of anything other than collaboration, urgency, and, a "let's get things done" attitude. Whether the Bush tax cuts are allowed to continue, or not, or if the automatic spending cuts take place, or are scaled back, there needs to be some clarity, some finality on that. And then middle-market companies can decide whether to add those new employees, invest in new plants and equipment, or not. But right now, they're just waiting. Manufacturing data came out, and it's edged down a bit-possibly a sign that companies already are hedging, waiting, scaling back a bit. They've seen what can happen in a recession, and if we hit another one, or things go very badly, they need to be prepared.
Flynn: Despite the uncertainty that's been mentioned, many of you in private equity have continued to do plenty of deals this year.
John Kenney, TSG Consumer Partners: We invest only in consumer products and some retail companies. What we've been surprised by is actually how stable our businesses have been. People are still reaching for what it is that makes them feel good, whether it's a beauty product, or certain food products, or something similar. We care and think about these broader issues but we don't really get impacted much by regulation - although there are some local regulations that have caused us much agita. But we're really impressed by what we see as the consumer's willingness to want to continue to live his or her life. I do think when we talk to business people - and we talk a lot directly to companies, a lot of getting to know them, a lot of direct approaches, and I'd say there's more apathy, than hope for clarity. Clarity would be wonderful, but the anxiety is that it's a bit of a morass. If we had leadership, one way or another, at least people would know what they were dealing with. As I look forward, if Obama were re-elected, and both houses went Democratic, I would hope and expect that our consumer base would still continue to consume, at some level. I do look at what's happening in China. Humans were created to consume. At the very essence of what we do, we're trying to feed people's desire to buy things to make their life better. That lets me sleep better at night than people in other industries, because we know that, if we can satisfy his or her needs, we'll do okay.
Flynn: Is the uncertainty around some issues, such as taxes, driving dealmaking before year's end?
Perkins: There's been an okay amount of deals closed year-to-date. There was a dismal amount of dealflow from January through June, and then a really big amount of dealflow in the months of July and August. Those folks, I think, are coming to market to try to beat the possible capital-gains tax change. But I don't think wanting to sell before things could get really bad again is spurring people to sell. The bigger problem is that people are choosing not to sell, because their numbers are tepid this year. I think they hope they can make them better in 2013. Kenney: We absolutely are seeing the willingness on the part of companies to have a dialogue with us now, which was not the case a few years ago. And it really is, I think, just a sense of uncertainty around the state of the economy globally, the state of taxes and regulation. There's a new willingness to sell to the right partner who can provide me some liquidity for myself as well as for my company. And if they can also help me move my business ahead-which, obviously, I think we can-selling isn't a bad idea. This is a bit of a new theory from what we were living with a few years ago and pre-crash.
Flynn: What impact is the election year having on access to capital and financing?
Jeff Cohen, Credit Suisse: I think from a financing standpoint, we've seen institutional loan activity and high-yield bond activity pick up significantly this year from the lows of 2008 and 2009, but we're still off from the levels that we saw just last year. And a lot of our financing activity this year is not M&A-driven. A lot of it is refinancing some of the maturity cliffs from some the bigger leveraged buyout deals of 2006 and 2007. We're also seeing dividend-recapitalization activity, because a lot of our private equity clients are very focused on showing returns of capital and progress to their limited partners. But they're hesitant to pull the trigger on transformative, large, high-risk acquisitions, simply because they have a very difficult time getting comfortable with the projections and confidence from the projections that they need during the investment period, to take on the kind of debt and pay the purchase price necessary to win assets in this market. That's why we've seen a lot of mismatches, where sellers' expectations have not been met in auction processes. We've spent an inordinate amount of time providing financial terms for clients, only to see the transactions not happening, because our buyers were only willing to go so far, and sellers just felt that was not a price they're comfortable with, probably because they bought the companies for 10, 11 or 12 times Ebidta many years ago and want to see that number again. I think with a change of administration, people will certainly feel more confident around what they can expect from employee costs. The sensitivities in people-intensive businesses are enormous, based on how you handicap "ObamaCare." In some cases, for information technology services businesses, or software businesses where some of our clients have literally 10,000 or 20,000 employees around the country, the implications could be a $50-million- to-$60- million Ebitda swing for a $300-million-to$400-million Ebitda business on a larger scale. And for a smaller company, it can still be very meaningful, depending on what their employee costs look like. So, it's very hard for our clients to put as much money to work as we would like to see. Therefore, we're creating opportunities through dividend recapitalizations for our loan investors and bond investors, who are looking to put capital to work in an environment where M&A activity is still very muted. There are industries that are much more heavily affected than the consumer sector, such as healthcare or business-sector services, which are more people-intensive. I think if we saw Mitt Romney put in office, we'd see a significant uptick in M&A activity in 2013.
Flynn: How are some of these issues affecting small businesses?
Jim Castro-Blanco, Chief Deputy County Attorney, Westchester County (R-N.Y.): I have been in the public and private sectors through different points in my career, so I understand what small-business owners, and those who are trying to build their businesses, are looking to do. I've represented many of them, and credit is the life of them. It's incredibly important to them when they're making decisions, not for the short term, but for the long term, in terms of expansion. And that means expansion for personnel, markets, products and the like. The lack of certainty is tremendously important. This is a watershed moment for the country. This election will not just set the tone, but set the road for the next generation. And I think the pick of U.S. Representative Paul Ryan (R-Wisc.) is also part of that. I think if you look at what Mitt Romney has done in his career as a private-sector person, as an investor, as a leader, the tone at the top cannot be understated. It is incredibly important who our president is going to be. We need someone in that office who will create an environment that is not just business-friendly but encouraging to business. That makes a huge difference, and it makes a huge difference in terms of certainty as well-when you know that every aspect of the administration is going to be friendly to business, every agency, every department, the lending departments, the folks who go out there to the state and local governments and help them make their municipalities friendly to business. And for the folks I have dealt with-some of whom employ five or six people, some of whom employ two or three hundred--it makes all the difference in the world whether your government-and that's city government, county government, state government or federal government-makes it a place where you can thrive, not just survive. I think someone who has the background that Mitt Romney has, in terms of being able to do that with companies over and over again, and who understands the necessity of an environment that is business-friendly and business-encouraging, makes all the difference in the world.
William Meehan, Rutan & Tucker LLP (sponsor): One thing that Fifth Street and several of our other lender clients have been the beneficiary of is President Obama's expansion of the Small Business Administration (SBA) by providing additional funding and additional Small Business Investment Company (SBIC) licenses. That's indirectly funding and benefiting private equity. That's the opposite of letting the markets "do their thing." That's government funding, but it's not government providing entitlements.
Flynn: The U.S. Supreme Court just upheld President Obama's Healthcare Act. Why is there still uncertainty about it?
Juan Alva, Fifth Street Finance Corp. (sponsor): A lot of the uncertainty of healthcare comes because of the way that the bill was written. There's a lot of "The Secretary of the U. S. Department of Health and Human Services shall...." So we've got "ObamaCare," but what does that mean? The taxes are starting sooner, but the actual provisions are coming later. Some of the more attractive and more politically palatable pieces of it are already in place, because they play well with the electorate. You can go to a rally and you can tell a bunch of college students, "You can stay on your parent's plan until you're 26." But people who are 22 to 26 years old consume very little healthcare anyway. So, that's a good talking point, but it really doesn't do anything. But the taxes are real. The taxes are coming into place next year. There was a rah-rah moment: You're going to get free checkups. That's not true. Anybody who's running a business has seen the healthcare premiums increase, and you know why? Because it's not a free checkup. Somebody has to pay for it. Just because you don't pay out of pocket doesn't mean that no one is paying for it. It's reflected in the premium.
Duff: I don't think there's going to be any repeal of the Affordable Healthcare Act. But I'd like to point out that, as tax payers, we all already pay for the uninsured. We all pay for people who walk into the hospital and don't have health insurance. Whether you agree with national healthcare or you don't, the fact is that we all pay out of our tax dollars right now money that goes towards hospitals, money that goes towards doctors, money that goes towards lost wages, lost productivity. I hear from small businesses, who are maybe a carpenter, or a music store, in my district, and they say they would love to hire more people. My "X" factor isn't what I'm going to pay the person. My "X" factor isn't how much time I'm going to give them for vacations. My "X" factor isn't how much time I'm going to give them for sick days. My "X" factor is: I can't afford to have 17 to 20 percent increases every year in healthcare costs. The government needs to help in some way, so I can grow my business. One of the things in the Stimulus Act that I think was a homerun was our electronic medical records. I see companies that have grown tremendously, and a lot of investors invested in those companies, because we're finally getting towards electronic medical records. I think it's going to save a lot of money. There are lots of places in healthcare where we can save money.
Flynn: Do you think most people in the private equity community support Governor Romney's bid for the White House?
Paul Murphy, Sentinel Capital Partners: I don't think you can say that the financial services community, in general, is strictly in Mitt Romney's camp. President Obama is a big fundraiser in the financial services community. (See "President Obama Has Friends in Private Equity, Too.") Certainly, I would say private equity is for Mitt Romney, just because a lot of people in private equity know him. The founding partner of our firm worked with Mitt Romney. People who know him respect him and like him and support him. The private equity community is a fairly close-knit community, and he's from that community. I do think that there is a sentiment in the private equity community that we are pro-business. Our business is investing in business. "You didn't build that," is a comment that, probably, was taken a little out of context and that, maybe, the president regrets, but I think a lot of people are looking at that and saying, "That's a window into your viewpoint and how you really think. And you don't think somebody in business is successful on their own." And, that is an inherently anti-business viewpoint. And when you're making a choice between more government or more business, you're inherently in favor of one and less in favor of the other. And I think the current president is in favor of bulking up government. That's where a lot of the jobs have been created in his tenure, in government. And my personal view is that a path for growth of this country is job creation in the small-business community. Small businesses are the growth drivers of this country and provide better jobs for people, who can move up the ladder and attain success. I would hope that if this current president is re-elected, or if Mitt Romney is elected, the next president will adopt a more pro-business standpoint and not view business as the enemy, but as a driver of growth. Rehnert: I think a lot of people in the private equity industry did support Obama in 2008. I know a lot of people who supported him and really believed he was a very intelligent candidate, who would learn what needed to be done. And a large percentage of those people have become very frustrated. So, I think that community is shifting. In 2008, I don't think the Republicans had a set of candidates that inspired a lot of confidence in the business community. I think Mitt and Paul Ryan bring a very different level of understanding, expertise and capability to the economy and how economic activity is encouraged, than the candidates four years ago.
Tannenbaum: I think it's very interesting that private equity, with Mitt Romney, all of a sudden became a big, big word. Not many people understand the private equity industry. The public is really confused. Bain Capital is a great firm, but it's upper-market private equity. It is not middle or lower. Rehnert: When Mitt was there, it was very middle market. Bain Capital today is a very different firm from where it was when he left. During the 15 years he was there, we did 150 transactions. Almost half of those were venture-growth transactions. The other half were middle-market to lower-middle market, leveraged acquisitions. So, that's really the background and experience Mitt has. There were a handful at the very end that would be considered large-cap transactions, like Domino's Pizza and Sealy Mattress, but that was really just in the year proceeding Mitt's departure.
Flynn: Has the spotlight shone on private equity throughout Romney's campaign been good, or bad, for the industry's public image?
Rehnert: I think the answer depends on what happens in November. If Mitt wins, I think it will prove to be good for private equity. If he doesn't win, I have a concern that there's going to be a backlash against business in general, not just private equity.
Juan Alva, Fifth Street Finance Corp. (sponsor)
Jim Castro-Blanco, Chief Deputy County Attorney, Westchester County (R-N.Y.)
Jeff Cohen, Credit Suisse
Bob Duff, State Senator (D-Conn.)
Russ Gerson, Gerson Group
John Kenney, TSG Consumer Partners LLC
William Meehan, Rutan & Tucker LLP (sponsor)
Paul Murphy, Sentinel Capital Partners
Gretchen Perkins, Huron Capital Partners
Geoffrey Rehnert, Audax Group
Leonard Tannenbaum, Fifth Street Finance Corp. (sponsor)