Capital markets are plain lousy, with no sign of turnaround seen

This is one quarter deal-makers would just rather forget.

Battered by the volatile credit markets, investment banks with strong Minnesota connections underwrote just seven initial public offerings, the lowest total in five years, according to the Star Tribune Quarterly Deals Report. Additional equity financing and private placements also were down substantially, suggesting widespread weakness across capital markets.

"This is probably the toughest of environments we have seen" in a long time, said Jon Salveson, head of investment banking at Minneapolis-based Piper Jaffray & Co. "The numbers are actually worse than the headlines."

Over the past three months, Minnesota-related investment banks managed just seven IPOs compared with 23 in the fourth quarter and 15 during the same period a year ago. Two of those seven deals originated from Piper Jaffray's operations in China.

Nationally, IPO dollar volume was up 144 percent as companies raised $24.2 billion through 25 deals compared with $10.2 billion through 67 deals in the first quarter 2007, according to Dealogic. But excluding Visa International's record-breaking $19.7 billion IPO, U.S. companies raised $4.5 billion from 24 IPOs, five of which were priced below or at the bottom of their pricing range.

Locally, the mergers and acquisition market held steady with 76 deals, slightly more than the same period a year ago. Nationally, mergers and acquisition dollar volume fell 28 percent, to $318 billion, but the overall deal count rose 26 percent, to 1,968 deals.

Foreign buyers took advantage of the weak U.S. dollar to snatch up some relative bargains. Minneapolis-based Lazard Middle Market advised Italian private equity firm Quadrivio SGR of Milan on the purchase of Audio Research Corp., a Plymouth-based manufacturer of amplifiers. Houlihan Lokey Howard & Zukin helped four American companies sell to foreign buyers.

Piper Jaffray advised St. Paul-based AppTec Laboratories Services Inc. on its $162.7 million sale to WuXi PharmaTech Inc., a major Chinese pharmaceutical services company. The deal is the largest Chinese takeover of a U.S. company since Lenovo Group bought IBM Corporation's personal computer business in 2004 for $1.75 billion.

Private equity clout wanes

The quarter also marked the declining clout of large private equity firms and the huge megadeals they consummated through cheap credit that has since dried up. There were only three deals for more than $10 billion.

"There are not many, if any, large deals getting done," said Peter de Vos, head of investment banking at RBC Capital Markets.

Private equity-sponsored buyout volume fell 65 percent, to $63.1 billion from the same year ago period, the slowest quarter since 2004, according to Dealogic.

"The credit markets have really changed since last summer," said Tim Kuehl, general partner of Norwest Equity Partners, a Minneapolis-based private equity firm. "It continues to get weaker, not stronger."

With debt less readily available, Norwest has adopted other ways to finance deals. Earlier this month, Norwest acquired Shock Doctor Inc., a Plymouth-based maker of sports protective gear, through an all-equity transaction. The use of equity was a way to assuage the owners' concerns that the deal would not collapse for want of debt financing, Kuehl said.

Experts say there are still deals to be done, albeit smaller ones. Middle-market volume, the deals worth $100 million to $1 billion that Twin Cities firms mostly specialize in, accounted for 21 percent of all mergers and acquisitions in the United States during the quarter, up 3 percentage points from a year ago.

Last month, Warburg Pincus, a private equity firm based in New York, completed its $239 million purchase of Lifecore Biomedical Inc., a Chaska-based medical device maker. Piper Jaffray advised Lifecore.

Piper Jaffray also assisted minority investors in trendy Blu Dot Design & Manufacturing Inc. with selling their shares to CHB Capital Partners of Denver. Blu Dot's three majority owners -- John Christakos, Charles Lazor and Maurice Blanks -- retain control of the Minneapolis-based home furnishings maker.

Credit woes will persist

But Salveson of Piper Jaffray said credit woes that initially curtailed large deals are creeping into the middle market. The Minneapolis-based investment bank, which specializes in middle-market deals, said revenues from advising companies on mergers and acquisitions was essentially flat at $25.3 million compared with the same quarter in 2007.

RBC Capital Markets' De Vos said the credit crunch is weeding out players that relied too much on debt to finance risky deals. RBC is gaining market share today because it avoided the debt frenzy last year, he said.

"Last summer, I would have told you that lending was a commodity," De Vos said. "Lending is no longer a commodity. We can dictate when or whether to do a deal."

He predicts that credit woes will persist.

"You will see the credit crisis and the dislocation of the marketplace for the rest of the year," he said. "I don't think it's totally over. We are in the third quarter of a four-quarter [credit crunch] game."

Thomas Lee • 612-673-7744