Uncharted territory

Hector Cuellar has been a dealmaker for nearly 28 years, and he's never seen a market like this. Not in 1982, when he witnessed the implosion of Latin American debt markets. Not in 1990-'91, when the U.S. economy sank into recession. Not in 1994, when Mexican debt imploded again, or in the dot-com bust of 2001.

Born in Cuernavaca, Mexico, and raised in Chicago, Cuellar has been president of Costa Mesa, Calif,-based McGladrey Capital Markets LLC since 2004. He was previously a managing director at Banc of America Securities LLC, in charge of the Los Angeles corporate office. Last summer, Cuellar was looking forward to a good year. Dealflow was up 8% over 2007 through August, and the midmarket had yet to see significant effects of the credit crunch. "We had an extremely strong inventory of mandates," Cuellar recalls.

Then, in September, Lehman Brothers Holdings Inc. went bankrupt, LIBOR shot through the roof and loan markets seized. "We started to see our countersign letters of intent fall away," Cuellar says. "Our clients were not performing because of the economy. Between the dislocation and commodity prices, the buyers started to retreat. Deals died."

Only two of the eight deals McGladrey expected to close in October came to fruition. None closed in November. Cuellar realized McGladrey had to act quickly and creatively to salvage any deals for the rest of the fourth quarter.

For Cuellar, who was in BofA's Mexico City office during the 1982 debt crisis, this was nothing new. "It was very similar in terms of drama [and] uncharted territory," he says. "New ideas required for a new era."

The principal challenge was to bridge the gap between buyers' and sellers' new value propositions. This was particularly true in commodities, where lower oil prices had buyers looking to renegotiate. The task, Cuellar says, involved "talking to both seller regarding their original objectives and buyer regarding the value propositions. Many of the strategics we sell to don't want to overpay, and they shouldn't, but if it really adds a lot of value to their business, they know that you've got to look to the long-term plan."

In one case, McGladrey had been working with International Lift Systems LLC, a Houston manufacturer of lift systems for oil and gas companies, which hired the firm after receiving what Cuellar calls "low-ball offers." On Dec. 18, ILS agreed to a deal with Lufkin Industries Inc. "It was a value proposition for Lufkin: a niche player, a reasonable size for a middle-market transaction, it got them into a new product line and geographically it was a great mix."

Still, the deal faced challenges, due to market conditions and the price of oil. McGladrey held talks with both sides to avoid a retrade. "Lufkin realized that while the price of oil was dropping quickly, they couldn't be driven by the volatility of the oil markets in the short run," says Cuellar. The deal closed in March.

In other cases, McGladrey had to help with refinancing. Several times in December, private equity firms that had agreed to a deal for a client saw thier lenders drop out. "There were a few mezz players we had to find and prove to them the companies we were showing were of sufficient quality," he says.

It was difficult. "People were very nervous about making loans," says Cuellar. Those who agreed to provide financing did so at outrageous rates. Cuellar and his staff found themselves keeping both client and buyer from losing focus. "You have to do whatever it takes," says Cuellar. "If the banker wanted information a certain way, we had to provide that."

It paid off. McGladrey closed five deals in the quarter -- all with private equity buyers -- and 45 deals total in 2008. The firm was not totally spared. It reduced staff and expenses by 38%, though the personnel cuts were mostly administrative.

Cuellar cautiously believes the worst is over. The firm has begun to bring ideas to international strategics, taking advantage of the dislocation suffered by the large firms. "It's all about mindset," Cuellar says. "A lot of PE groups and M&A professionals seem to have a sour mindset. It's easy to get down. We view this dislocation as an opportunity."