Buyouts help drive stock market rally

NEW YORK (CNNMoney.com) -- Big deals - many of them by private equity buyers - have helped power the stock market's recent rally, but the best days of the buyout boom may be over.

Private equity firms have been on a global buying binge, announcing multi-billion dollar deals with ever greater frequency. In the latest deal in Europe, for example, buyout firms are battling for Alliance Boots (Charts), Britain's largest pharmacy, and at around $22 billion, the deal would be the biggest buyout ever in Europe.

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In the U.S., deals announced this month alone include the $25 billion buyout of college loan provider SLM (Charts, Fortune 500), better known as Sallie Mae, as well as the $29 billion takeover of credit-card and payment processor First Data Corp (Charts, Fortune 500).

The wave of private equity deals has helped drive merger activity, which in turn has helped the stock market claw its way back from a sharp selloff in late February.

The Dow industrials (up $112.80 to $12,921.43, Charts) closed at a record high for a second straight session Thursday, and the blue-chip barometer now has 13,000 in its sight.

Market analysts attribute the rebound in stocks to a variety of factors, including a strong start to what was expected to be a bleak earnings season as well as recent signs that consumer spending is holding up well despite slowing economic growth.

But a focal point for the market has also been deal activity. Big deals are encouraging to investors because they can be a sign that other companies may get bought - typically at a premium to their stock prices, analysts say.

"M&A always makes investors feel good because it gives them the feeling that there are attractive buying opportunities in the marketplace," said Alfred Goldman, chief market strategist at A.G. Edwards.

The value of merger deals announced through Wednesday jumped to $544 billion in the U.S., according to deal tracker Dealogic. That's up from $411 billion at the same time in 2006 - which turned out to be a record year for mergers and acquisitions.

A rise in take-private deals has also taken company stock out of public hands. With less supply, demand has grown and helped boost the prices of shares left in the market.

Private equity firms buy companies - oftentimes public firms - with mostly borrowed funds and try to grow or turn around the target away from the glare of the public spotlight. Their aim is to sell out for a profit, usually within three to five years.

These sorts of deals have grown in size, making private equity a powerful force in financial markets. In the first quarter, private equity firms accounted for nearly 26 percent of overall U.S. deal activity, and three of the top 10 deals announced during the period involved private equity buyers, according to Thomson Financial.

Private equity funds have no shortage of resources. Hungry for big returns, investors are pouring money into private equity shops. Research firm Private Equity Intelligence expects private equity funds to raise a stunning $500 billion this year, topping the record $432 billion raised in 2006.

But industry players who convened for an annual private equity conference hosted by industry magazine Buyouts this week weren't celebrating the boom in the industry as much as they were worrying about market conditions.

Competition has gotten so intense for deals that prices paid for companies are rising, they lamented. And eager lenders are financing many deals that shouldn't even get done in the first place, a sign that the market may be headed for a downturn, they said.

Daniel D'Aniello, co-founder of private equity powerhouse Carlyle Group, said at the conference that some portfolios may have loaded up on too much debt, and he cautioned about a turn in the credit markets, saying it was "naive" to presume lenders would keep lending at favorable rates forever.

A tightening of credit, which has been the fuel behind the buyout binge, would rein in the shopping spree. It would also remove a powerful force in the world of mergers - and a key support for stocks.

But few these days are willing to predict when the flood of cheap debt will dry up. Some in fact don't see any signs of a coming pullback in buyout activity. They argue that unlike the last buyout boom of the 1980s, when private equity was a more exotic investment vehicle, it's become much more mainstream today.

"There is a structural demand for private equity coming from pension funds and other types of investors who want to move away from day-to-day portfolios," said Tom Sowanick, chief investment officer at investment adviser Clearbrook Research.

This is an updated version of a story that ran earlier on CNNMoney.com.