Pace of activity slows as deals take longer and prices peak.

Merger activity tapered off in the third quarter as private equity firms and corporate buyers put on the brakes alter gunning for deals earlier this year.

Though 2005 is still expected to be a strong year for merger activity, many investment bankers say deals are taking longer to complete and prices are nearing a peak. There is more caution in the market because of outside economic factors as well, including high gas prices, rising interest rates and the expected economic impact of Hurricane Katrina.

"It's still a robust market, a seller's market, but it's not as strong as it was over the summer," said Randy Bort, managing director in Los Angeles for Mereanti Group LLC. "Energy prices, interest rates and the hurricane are starting to affect people's outlook."

Third-quarter merger activity in California fell 20.6 percent to $48.9 billion from $58.5 billion in the second quarter, according to Goldsmith Agio Helms, an investment bank based in Minneapolis. Still, announced deal value was 55 percent higher than the year-ago third quarter.

Investment bankers tend to pay far more attention to sequential merger data because it shows whether the market is expanding or contracting.

"We had a very strong second quarter and the third quarter is slightly weaker, but our expectations are for continued strength in the mergers-and-acquisitions market," said Lindsey Alley, managing director of consumer, food and retail at Houlihan Lokey Howard & Zukin. He said that the level of activity in the first nine months of 2005 has been consistent with last year.

In September, 77 companies announced plans to either buy or sell a business in Los Angeles County for a combined deal value of $2.4 billion, according to Goldsmith Agio Helms. That is compared with $4.7 billion in deal value for August, when 74 companies changed hands. (August figures included Public Storage Inc.'s $2.49 billion hostile takeover bid for rival Shurgard Storage Centers Inc., which analysts say is unlikely to be consummated.)

The drop in dealmaking is more pronounced with statewide figures. In the third quarter, 514 California companies were bought or sold, down from 607 in the second quarter.

Goldsmith Agio compiled the data from three sources: Capital IQ, a unit of Standard & Poor's; Factset Mergerstat LLC, and OneSource, a division of infoUSA Inc.

Notable deals

One of the biggest deals last month was distressed debt investor Oaktree Capital Management LLC's bid for the European apparel business of Sara Lee Corp., which includes brands such as Wonderbra, Playtex, Unno and Dim and had sales of $1.2 billion last year. Oaktree edged out two private equity firms, Sun Capital Partners of Boca Raton, Fla., and Paris-led buyout firm PAI Partners in a deal that was watched closely because of Sara Lee's restructuring. Oaktree's bid was not disclosed.

L.A.-based Oaktree also played a role with UK-based Wellspring Capital Partners in the sale of JW Aluminum Holding Co., based in Mount Holly, S.C., to Calgary-based Superior Plus Income Fund for $350 million.

Brentwood-based Post Advisory Group LLC completed the largest deal in September, selling Peregrine Systems, a San Diego-based software developer, to Hewlett-Packard Co. for $503 million. Bear Stearns & Co. was Post's advisor on the deal.

Tennenbaum Capital Partners LLC of Santa Monica cashed in handsomely on its nearly 30 percent stake in Party City Corp., which sold for $361 million.

Managing Partner Michael Tennenbaum, formerly with Bear Stearns & Co., made a $30 million cash infusion in Party City in 1999. The Rockaway, N.J.-based company, which was being run by a committee of four executives headed by Tennenbaum, was sold to two Boston-based private equity firms, Berkshire Partners LLC and Weston Presidio, through holding company AAH Holdings Corp.

Ed Villaneuve, managing director at Goldsmith Agio in Los Angeles, said Tennenbaum has "an uncanny ability to look at companies that are temporarily troubled and see the value in them."

He also said that the merger market continues to be dominated by leveraged buyout firms and financial sponsors with flexible capital structures.

Villaneuve said low interest rates and easy-to-get credit continues to drive merger and acquisition activity, and pricing levels have risen about 10 percent since last year. He thinks banks will start to pull back on lending activity, which will dampen prices.

"What you'll start to see is an uptick in any type of default rates, particularly in second-lien financing, and senior lenders will become much more cautious," he said. "The only way you really get high prices is if the banks are loose with lending."

Second-lien debt, also known as tranche B loans or junior secured loans, has become a popular form of financing, squeezing itself into more financing structures and overtaking mezzanine debt in the second quarter in terms of overall issuance.

But the mushrooming market in second-lien loans has virtually no track record in a downturn, causing speculation that problems could crop up later. The function of a second-lien loan is to provide liquidity to borrowers who have exhausted their credit with existing senior lenders.

Several companies that put themselves on the auction block--only to find there were no buyers--have found a way to retreat from the public markets and simply go private.

Mossimo Inc. in Santa Monica is one example of the trend. Its founder, Mossimo Giannulli, a 65 percent stakeholder, has agreed to buy the remaining publicly held shares for $5 each, or roughly $27 million.

"We are seeing increasingly smaller public companies looking to sell or go private in the face of higher costs and less coverage by analysts," said Houlihan Lokey's Alley.

Highlights

* Platinum Equity LLC, the $700 million Beverly Hills-based buyout firm owned by billionaire Tom Gores, acquired computer modem maker U.S. Robotics Corp. The company will retain its current management and will be used to acquire other technology firms.

* Los Angeles-based Cedars Bank agreed to be sold to First Community Bancorp for $120 million in cash. Cedars will be merged into Pacific Western National Bank, a Los Angeles-based unit of First Community. Cedars Bank has offices in Los Angeles, Sherman Oaks, Century City, Irvine, Norwalk and San Francisco.

* Los Angeles-based Rampage Clothing Co. sold its Rampage brand of women's apparel to Iconix Brand Group Inc. The Rampage label added a fifth brand to the Iconix portfolio, which included Candle's, Bongo, Badgley Mischka and Joe Boxer.

* Chicago-based Aon Corp. sold Woodland Hills-based Swett & Crawford, the largest wholesale insurance brokerage firm in the U.S., to private investment firms Hicks Muse Tate & Furst Inc., Banc of America Capital Investors and Emerald Capital Group Ltd. The sale will allow Swett & Crawford to expand its brokerage and underwriting functions.

Total Debt as Multiple of EBITDA

Bank Debt/    Non-Bank Debt/
  EBITDA         EBITDA

1.7                3.5
1.2                3.3
1.2                2.9
1.5                2.2
1.4                2.4
1.7                2.3
1.0                3.2
1.7                3.3
1.6                3.4
1.6                3.4

Note: Table made from bar graph.