Buyouts seen bigger, possibly peaking in 2007

By Emily Chasan

NEW YORK (Reuters) - Corporate buyouts are likely to reach their highest level ever next year, but that may also signal the beginning of the end of the private equity mania that has gripped Wall Street this year.

Private equity firms are enjoying their most profitable period in more than five years, helped by favorable debt markets and a steady economy. Leveraged buyouts (LBOs), as their deals are known, have risen to comprise a fifth of global merger and acquisitions activity, up from just six percent a few years ago.

But at the Reuters Investment Outlook 2007 Summit in New York, market analysts said they are increasingly worried that private equity deals are going to turn out badly and next year will be the peak of the cycle for privately financed takeouts.

"It probably peaks next year," said Robert Morris, chief investment officer at Lord Abbett & Co. "If I were going to be in the career counseling business today, I'd say it is too late to get on the private equity train ... you want to be a distressed debt specialist."

Private equity firms typically pay for deals with a small amount of their own cash and borrow the rest, flooding the bond market with company debt. So far it has been easy to find buyers for this debt, but Morris worries it is going to become more difficult.

Still, some said rampant speculation on Wall Street about the possibility that buyouts would soon top previous records is also not far off the mark.

"There's no reason why we can't have a $100 billion buyout," said Margaret Patel, portfolio manager at Pioneer Investments. "I think we can motor along with ever larger LBOs or private equity buyouts. Equity is so fundamentally cheap ... I think the way it resolves itself is much higher equity prices."

The large private equity funds are increasingly going after big targets. The biggest LBO to date is Kohlberg Kravis Roberts & Co.'s roughly $33 billion purchase of RJR Nabisco in 1989.

Recent speculation has centered around home improvement retailer Home Depot Inc. (HD.N: Quote, Profile, Research, Stock Buzz) -- which has a market capitalization of more than $77 billion -- but the company denied rumors earlier this month it was in talks about a leveraged buyout.

Private equity firms look for companies with strong cash flows because they need the cash to pay down the debt used to finance the deal. But some of those companies known for strong cash flows are already getting more richly priced, says Michael Winer, portfolio manager at Third Avenue Real Estate Value Fund

TAREX.O.

Blackstone Group's $20 billion agreement in November to buy Equity Office Properties Trust EOP.N, the largest deal ever for a real estate investment trust (REIT), has drawn attention to several other companies in the sector.

"In the public markets, the stock prices of the REITs today do in fact reflect private market value," Winer said.

But with so many big deals some say the risk of a deal that doesn't work and shakes up the private equity market is growing rapidly.

"There is going to be a blowout," Morris said. "I don't know if it is going to be a 60 mile-an-hour or a 90 mile-an-hour one, but there is going to be a blowout here somewhere down the road."