* Global M&A is down 26%
* Global private equity-sponsored M&A is down 75%
* U.S. M&A is down 41%
* U.S. private equity-sponsored M&A is down 84%
* U.S.-based buyout firms raised $65.6 billion in fund capital in Q2, compared to $76.7 billion in Q1 (source: Buyouts Magazine).

Much more to come…

-US private equity shops will continue to take investments from foreign entities in an increased capacity.

-Changes in carried interest law could lead to an influx of deals in the fourth quarter of this year.

-Further, FAS 121(R) and FAS 160 will motivate firms to close deals before December and take on more minority stakes by the end of the year, respectively.

Industry specific conclusions:
-Consumer Products companies will shed non-core and underperforming assets.

-Energy companies in the equipment and services sector will experience a wave of consolidation to last another year at least. Master Limited Partnerships (MLPs) are just beginning to consolidate thanks to struggles with competition and deal pricing.

-Within technology, Internet companies are the most attractive and small and medium-sized ad-driven businesses will see consolidation, driven by interest from European and Asian suitors.

-PwC predicts sales in the auto industry will be hurt this year, falling to its lowest number in 13 years.

-The firm believes opportunities to infuse capital into financial services businesses is an attractive one.

I asked Phil for his thoughts on valuations in the lower middle market and investing in Canada.

EG: KPP has around two thirds of its $500 million fund left to deploy. Where are you seeing the most deal opportunities and at what prices?

PC: We do primarily non-control investing, and we have seen more opportunities for those types of deals. Also, we feel there are fewer competitors for those kinds of deals.

Anecdotally, owners are saying valuations aren’t attractive now, but they still need the capital to acquire a competitor, invest in more managers or develop new products. They don’t want a traditional recap with private equity because the offers are lower now, so they do a non-control deal. Two years ago, there were more change of control opportunities, but today its more non-control.

Further, valuations of companies with EBITDA between $5 million and $20 million have come down in the sectors we’re investing in. Housing, automotive and industrial manufacturing have seen valuations come down.

EG: KPP has done a few deals in Canada recently, what is attractive about buyouts in Canada, and what should LBO shops remember when looking at deals up there?

PC: Building materials and building products companies in Canada continue to be areas we love to invest in, because we have the operational expertise in the area, and the housing bubble never achieved the bubble status that the U.S. market had. It’s been more consistent and stable.

Right now it’s a little more challenging because Canadian dollar has appreciated more than the U.S. dollar. Also, transaction expenses are typically higher because Canada does not recognize the LLC as a legal entity, making structural issues more challenging than you’d think.

KPPs Canadian building products holdings include Atis Group, a windows and doors maker, and Plastival, a vinyl fencing and railing maker.

Longtime readers know that the current title-holder is Hummer Winblad, for its Napster investment in the midst of that company’s legal morass. And it will remain that way, as Microsoft’s Facebook deal presents neither the legal difficulties nor the likelihood of a total write-down. In fact, it’s probably been a good strategic deal for Microsoft, which doesn’t need to sweat the small stuff (i.e., cash). The only caveat to that last part is that Microsoft is now expected to overpay for all its other acquisitions, which has led to a trickle-down throughout the Web 2.0 market. For example, macro valuation inflation helped scuttle the Internet roll-up envisioned by Ross Levensohn and Jon Miller — as their targets upped their respective asking prices.

Anyway, back to my thesis. The reason this might be one of the worst VC deals is that all of its negatives fall on its supposed beneficiary: Facebook.

This isn’t a dilution argument, but rather one of public perception. Social networks partially work because of functionality, and partially because of bandwagon popularity. You don’t necessarily join and use Facebook because it works well, but perhaps because your friends have joined and use it. And, as has been proven with MySpace-Facebook-Beebo, that usage can be fickle and prone to migration.

Public perception is very important, and I think the Microsoft investment has set Facebook up for a giant egg pie in the face. For example, imagine the endgame is to go public. If so, there is no way a company with such low revenue could possibly get near a $15 billion valuation (this isn’t 1999, and Facebook isn’t Google circa 2004).

So let’s generously imagine it could get $5 billion. Know what the headline will be? How about: “Facebook Files for IPO.” Looks good, but check the subhead: “Social networking company worth just one-third of 2007 valuation.”

Ditto for an acquisition, as no company in its right mind would pay close to $15 billion for Facebook. Yes, that includes Microsoft.

What this means is that Facebook is going to lose heat upon liquidity, and a loss of heat can lead to a loss of cachet. Remember all the buzz when Facebook got the $15 billion? Now imagine it again, but with a negative spin (particularly outside the TechMeme bubble, where most of Facebook’s users actually live).

All of this is exacerbated by the fact that Facebook never really needed to take the Microsoft money (could have gotten it elsewhere), and certainly didn’t need to confirm the valuation in a press release.

The only out I see for Facebook is to take another big strategic investment at the $15 billion figure. It could provide liquidity for Facebook’s early VCs like Accel (whose LPs would really like some payoff) and other employees looking to turn their paper green. And, yes, that probably means Microsoft again. If not, that original investment will hurt Facebook far more than it will help it.

Note: Much of the above argument was first made (to my ears) by venture capitalist Stewart Alsop, at this year’s VC in the Rockies conference. It took my a while to come around, but I’m now there. Hope he doesn’t mind the pilfering.

Only five VC-backed companies went public on U.S. exchanges last quarter, raising $282.73 million. That’s the lowest offering and raise figures since Q2 2003, and way off from the 31 VC-backed IPOs that raised over $3.04 billion in Q4 2007.

VC-backed exits via M&A was even worse, by comparison to other quarters. Only 56 VC-backed companies were acquired in Q1, which is slower than any other quarter since Q1 1999. The largest M&A exit was Dell’s $1.4 billion acquisition of EqualLogic.

Sportscaster: “So what are you going to do now that you’ve just won the biggest game of your life?”
QB: “I’m going to Disneyland!”

One may expect to hear that refrain from Silicon Valley CEOs for the next two years after Disney spilled word of a new group designed to buy startups to TechCrunch.

TC reports that the group will likely buy more than 20 startups in the next 24 months.

That’ll be a real boon to VCs that are becoming increasingly interested in the entertainment space. Movie, music and recreational software startups collected $792 million from VCs during 2007, according to Thomson Financial (publisher of PEHub.com).

Well, better late than never. Oberon Media recently submitted two filings with the SEC, which indicate it spent approximately $70 million on acquisitions. This included an $18 million common stock exchange, and $52.52 million in newly-raised junior preferred stock. It also said that the extra “working capital” funding came in at around $47.4 million.

Oberon CFO Jeff Epstein declined to comment on the filings, saying that Oberon is a private company that does not want to provide any information outside of what is legally required.

Oberon shareholders include Oak Investment Partners, Comcast Interactive Capital, Capricorn Management, Goldman Sachs, Lehman Brothers and Morgan Stanley. It also lists former I-play backers like Apax Partners and Argo Global Capital.

Download the filings:
Oberon’s junior preferred filing: Oberon_Preferred.pdf
Oberon’s common filing: Oberon_Common.pdf

1. Why do telecom and Internet services providers need another company selling bandwidth?

Scarano: This is a consolidation set of activities, where we end up with net fewer companies competing across regions in the country. The equity investment is to acquire and therefore displace competition over time, not add to it.

In the regions where we have already acquired networks – and in those where we’re seeking to acquire – there tends to be one to three players: The incumbent and one or two others. It’s very different than it even was two or three years ago. In the second and third tier markets – where most of the networks we’re acquiring lie – I think a casual review would show that competition is low.

2. Was it fait accompli that Columbia Capital and M/C Venture Partners would be involved, given that they funded ICG Communications?

Scarano: It was a mutual decision. Dan Caruso and I spent time with multiple private equity firms, and ended up concluding that this group – including Columbia and M/C – were the best option.

3. Why raise only private equity, instead of a combination of equity and debt?

Scarano: We actually do plan to bring in additional leverage in the form of traditional debt. The benefit of leading with fully-funded private equity commitments is that it allows us to be very decisive in our acquisition negotiations. It also lets us eliminate traditional contingencies like financing contingencies, and are able to win quickly as a result.

4. You’ve already announced four deals. At what point do you need to raise additional private equity, if at all?

Scarano: Our current trajectory and private equity funding would enable us to close a total of six to eight transactions, and possibly as many as 10. We also might have much more dry powder, depending on how successful our debt-raising activities are. If we feel the need, we would certainly contemplate raising additional private equity.

5. Who will be taking board seats, as part of the financing?

Scarano: All the firms have representation on the board, although three have voting rights and two do not… From M/C we have Gillis Cashman and Rob Savignol. From Columbia we have John Siegel and Jim Fleming. From Oak we have Tony Downer. From Centennial will be Rand Lewis, and from Battery Rick Frisbie.

Bullet points include:

* Private Equity M&A accounts for 20.5% of year-to-date M&A activity, up nearly 4 percentage points from last year at this time. Private Equity activity in the U.S. accounts for 35% of overall activity, up from 16.3% of activity during the year ago period. 

* Private Equity buyers account for 12.6% of this year’s activity in Europe, down from 22.5% at this time last year. 
* Worldwide M&A volumes totals $2.18 trillion, a 77% increase from last year at this time; US Volume totals $802 billion, a 54% increase; European Volume totals $983.6 billion, a 129% increase. 

* Worldwide Private Equity M&A totals $447 billion, a 114% increase from last year at this time. U.S Private Equity activity is up more than 200% over year-to-date 2006. 

* Worldwide Strategic M&A totals $1.7 trillion, a 69% increase from last year at this time. 

* Triple digit year-over-year growth in a diverse number of industries – Financials, Industrials, Real Estate, Consumer Staples and High Technology. 

* Worldwide targets in the Retail and Telecom sectors are the only groups to lag last year’s activity. 

* Private Equity buyers are creeping into traditionally non-private equity sectors including – Financials, Energy & Power, High Technology and Telecom.

I’ve received dozens of emails this morning asking if the rumors are true that Thomson Financial has offered to buy Reuters. My official response – per internal dictate – is that I have no response. My unofficial response is that I have absolutely no idea, as my efforts to shimmy up the information totem poll have met with total failure.

In general, however, I do not believe the Reuters approach (no matter who made it) is a direct response to Murdoch’s bid for Dow Jones. It’s just too quick. I can’t imagine any large corporation – or even private equity firm – putting together even an informal offer for Reuters in less than three days. There is certainly the possibility that the approach was made weeks ago and that Murdoch/DJ promoted Reuters to ‘fess up, but that’s a far different scenario.

Moreover, I’m not so sure that big financial media companies like Thomson, Reuters, etc. are in a panic over the prospect of News Corp. acquiring Dow Jones. In fact, they might be thrilled – particularly if Murdoch is willing to eventually part with some of the more data-driven business units that don’t provide enough strategic value to his print, online and TV news business…

*** In a related download, here’s a Thomson research note on publishing sector M&A: PublishingM&A.pdf