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Introduction    PE's debt-driven dynamics   A new struggle for LPs   Big funds enter the midmarket   The debt crisis in Europe   The problem with secondary buyouts   A business model for WikiLeaks   Regulators' new derivative rules   China's primary resource dealmaking   Time's ticking for CLOs   The midmarket bounce-back   Arb funds find cash   China as tech IPO player   The real price for natural gas   Capitol Hill does the tussle   Delaware: Arb of corporate jurisprudence   An alternative to pay TV   Money flows post-Ch. 11   Texas Rangers Ch. 11, firsthand

There are several trends at work here. After the busted deals of the financial crisis, megabuyouts remain a real leap. Moreover, LPs appear to be disillusioned with some larger buyout firms, aiming to allocate their capital to investors working the middle market. Observers believe that some large-cap funds will be reaching down to try and deploy capital into middle-market firms. For example, Court Square Capital Partners recently purchased Helena, Ala.-based MailSouth Inc., a company with $170 million in annual revenue that provides mail-marketing services in rural America.

This activity in the middle market seems certain to set off a scramble for acquisitions as well as jack up prices and debt.

Leon Black, who runs Apollo Management LP, a bona fide megafund, said at The Deal's recent The Deal Economy 2011 conference that "the jury's still out" on whether midcap buyout funds represent better opportunities than large-cap funds. The fact that there's a jury to begin with suggests how relatively rare and poorly performing large buyouts have been. True, 2010 saw a so-called private equity resurgence and a hot junk bond market. Yet most returns have come from releveraging existing portfolio companies rather than exiting. And any buyout of more than $1 billion this year has been arguably either overpriced (Burger King Holdings Inc., Syniverse Technologies Inc.) or a defensive move, with buyout shops picking up companies they're familiar with -- or even owned before -- or only investing in companies that don't vary much from one cycle to the next, or both (J.Crew Inc.).

Symptomatic of this frothy market are the increasing numbers of dividend recapitalizations. While big buyouts such as HCA Inc., Dunkin' Brands Inc. and Petco Animal Supplies Inc. made headlines for sizable dividend recaps, middle-market sponsors employed them even more heavily. In fact, there was more dividend recap volume than leveraged buyout activity in the fourth quarter in the middle market for the first -- and only -- time since the first quarter of 2005, according to data from Thomson Reuters' Loan Pricing Corp. (Reuters defines a middle-market company as having a market cap of $500 million or less.) Meanwhile, middle-market bankers are saying this year's end is the most active they've ever had -- including before the crisis. If debt markets are going to continue feeding this type of activity, the odds are quality will take a hit.

Look no further than National Vision Inc., the No. 4 optical retailer in the U.S. and a portfolio company of Berkshire Partners LLC. "Lenders barfed all over it, first of all, but now it's back in the market," colorfully notes a senior analyst who tracks middle-market loans on the rejection of a $220 million term loan for a National Vision recap in April. LPC reported that the loan was pulled because the company had too much of its business concentrated in stores it operates inside Wal-Marts whose leases expire in two years. That, coupled with its relatively small size, makes National Vision a credit concern. Yet it still managed to close on a $200 million term loan in mid-November, albeit at around a 12% yield, according to LPC.

One investment banker says this is exactly what the Federal Reserve had in mind in keeping interest rates low: to induce investors to take on more risk. Indeed, there's been some selectivity in both the larger and midcap market, with prices rising or falling on the quality of the credit.

As National Vision shows, not every recap sailed through. There's not much mezzanine in recent middle-market dividends (five out of six middle-market dividend recaps in November had only senior debt), and the leverage multiple was a conservative 3.7 for the first three quarters, according to Standard & Poor's Leveraged Commentary & Data, which defines middle market as under $50 million Ebitda.

But now debt investors have recognized this situation and, like starving men, are likely to start buying anything on offer in the middle market. The surge in recaps is likely to be followed by a spate of M&A in 2011. One can argue -- and every middle-market dealmaker does -- that this doesn't compare to the pre-2008 market. But it's the comparative returns that are at issue here. Junk is priced so low that yield seekers have been getting equally good returns on middle-market senior debt for less risk. That window was brief, however, and will close quickly.