Going private transactions — deals in which a private equity sponsor (or club of sponsors) agrees with a public company’s board to cash out the public company’s stockholders, thereby causing the public company to delist and become a private entity owned by the private equity sponsor and the company’s management — have  increased as part of the upturn in the general M&A market. Will this trend of increased going private activity continue? Yes, so long as each of the following four market conditions exist:
– Equity is Available: Do private equity sponsors have equity capital that they are willing to deploy in going private transactions?
– Leverage is Available: Are financial institutions (and the leveraged loan syndication market) “open for business”, with such institutions willing to make new loans to support going private deals?
– Equity Market P/E Ratios are Favourable: Are public company “targets” trading at a level that permits going private transactions to clear the market?
– Strategic Position Favours Private Equity Sponsors: Are potential strategic acquirers unable (or unwilling) to top the private equity sponsor’s proposed going private deal?

In 2006-2007, all four of these ingredients existed in the market, and the result was a spectacular wave of going private transactions in the US and the UK. In this period, Carlyle’s David Rubenstein publicly predicted that there would be a $100bn going private deal. As it turned out, the largest going private deal completed in the 2006-2007 cycle was KKR and TPG’s $44bn acquisition of TXU.

So where is the market today? In the US, the market exhibits each of the four necessary ingredients for a robust level of going private deals:
– Sponsors’ war chests have abundant equity.
– Stock markets are trading at levels that will not prohibit going private transactions. There is a limit on the price that a private equity sponsor can pay for a public target. A target’s stock must be trading, and expected to trade, below such a price for a going private proposal to be attractive to stockholders.
– Strategic companies are not, at the moment, positioned to be the inevitable winners in competitive bidding wars for public companies.
– Financial institutions are prepared to make some new leveraged loans.

So, in the US, deals are getting done and new deals are in the pipeline. At the moment, the relatively limited amount of available leverage constrains both the volume of going private deals, as well as the maximum size of any individual deal. In today’s market, Mr Rubenstein’s prediction is too optimistic by an order of magnitude; sponsors are currently contemplating transactions with a ceiling of $10bn.

Where will it go throughout 2010? Watch the leveraged loan market. If the leveraged loan market continues to improve in 2010, and the rate of improvement continues to accelerate, the pace of going private transactions will also accelerate and the size of transactions will increase.

In the US, the legacy of the more than 20 going private transactions announced during 2006-2007 that never closed cannot be ignored by boards and their advisers. Boards (and their advisers) have learned from these “busted” going private deals that there needs to be, to use the phrase making the rounds in today’s negotiations, “absolute certainty” that the committed financing will be there at closing; “absolute certainty” that the target shareholders will receive their cash. The busted going private transactions illustrated that there was some degree of conditionality to the funding of the financing commitments, and that there was some daylight between the financing commitments and the cash.

Today’s boards would like to remove all of this conditionality. In essence, they would like to obtain the functional equivalent of a letter of credit from the private equity sponsor and its lending banks. In the UK, such “certain funds” are required by law. Before a private equity sponsor can launch a going private transaction, it must have unconditional commitments from its financing sources and an independent investment bank must review such commitments and deliver its own opinion that such commitments are certain funds.

In the US, there is no similar regulatory requirement. At present, institutions providing financing commitments to US going private transactions do not provide the functional equivalent of the UK certain funds commitments. This is the case even for the US operations of a financial institution that provides, through its UK operations, such certain funds to UK going private transactions.

Could boards of targets push for certain funds? There is no legal, regulatory or other roadblock preventing a US lending institution from making a certain funds commitment; lending institutions are, however, reluctant to take on the incremental risks associated with certain funds. It is, therefore, a matter of pricing. How much will lending institutions charge for such unconditional commitments? As any such change will presumably reduce the cash price offered to a target’s shareholders, will a target’s board be willing to make this trade of “absolute certainty” on the financing for a lower price? These are the key questions that remain to be answered in today’s boardrooms.

It will be interesting to watch whether certain fund commitments become part of the deal landscape in the US in 2010. If they do, the last half of 2010 will be extremely busy.

Kirk A Radke is a partner at Kirkland Ellis LLP