By LAURENCE FROST
The Associated Press
Friday, February 3, 2006; 1:32 PM

PARIS -- The barbarians are back on top of the world _ at least for now.

Private equity dealmaking broke global records in 2005 and will probably do so again this year, bankers and economists predict.

But as borrowing costs rise and competition from corporate bidders heats up, tougher times could lie ahead for buyout wizards like Kohlberg Kravis Roberts, whose purchase of RJR Nabisco inspired the bestseller "Barbarians at the Gate."

Private equity firms struck deals worth $396 billion in 2005, a third straight record year and a 51 percent increase over 2004, according to Thomson Financial _ outstripping a 39 percent rise in overall mergers and acquisitions business.

The buyout houses also raised $261 billion in new investment, London-based Private Equity Intelligence calculates, another all-time high. About one-third of the newly pledged cash comes from pension funds, responsible for managing millions of workers' retirement nest eggs.

"There's more money than ever before in private equity funds," said Neil Austin, a corporate finance partner at accounting firm KPMG. He noted that the funds are increasingly joining forces to take on bigger deals.

In the largest leveraged buyout of 2005, Apax Partners teamed up with Blackstone Group, Providence Equity, Permira Advisers and KKR to acquire Danish telecommunications operator TDC A/S for $12.0 billion.

The TDC buyout topped a European-led surge in take-private deals _ those that ultimately remove the target company's stock from public trading. While U.S. deals doubled, private buyouts of European targets jumped more than fourfold in value.

Overall, take-private deals rose by more than 150 percent worldwide to $97.4 billion, beating the previous record of $85 billion in 1988, before inflation adjustment. The $31 billion Nabisco deal of that year remains the biggest ever leveraged buyout.

The take-private bonanza also eclipsed growth in take-public deals. Initial public offerings rose 20 percent to $167 billion globally, despite a 15 percent drop in the United States _ widely blamed on the burden of Sarbanes-Oxley legislation and increased shareholder litigation risk.

Private equity funds often use IPOs to take their profits. But the frenetic pace of buyout activity had also slowed new listings, Austin said.

"Very often it's one private-equity house selling to another rather than IPO'ing the business," he said. "These are two reasons why you've had a drop-off in the U.S. IPO market."

Increasingly, though, the big funds are facing competition from industrial bidders for prime assets, amid a return of corporate appetites for acquisitions.

Midway through 2005, Providence, Blackstone, Permira and the Carlyle Group were getting close to acquiring Amena, Spain's No. 3 mobile network. Then along came France Telecom and _ in the words of leading investment banker Paulo Pereira _ "snatched the business away."

Pereira, who quit as Morgan Stanley's head of European M&A last week to join Wall Street star Joe Perella's new firm, sees the $7.7 billion mobile-phone grab as a portent of new challenges facing the buyout specialists.

"The cash-flow position of the corporates is stronger than it has been for the past four years and corporate confidence is back," he said. "So you have financial sponsors with unprecedented firepower, and you have the corporates back and very much wanting to transact."

Last year's biggest take-private deal was a corporate takeover. Kansas-based conglomerate Koch Industries Inc. agreed to pay $12.6 billion for Georgia-Pacific Corp., a paper products maker, displacing Cargill Inc. as the largest privately held U.S. company.

The favorable debt environment that has underpinned the buyout boom is also changing. This week, the latest in a swift succession of hikes brought the key U.S. interest rate to 4.5 percent, its highest for almost five years.

Another quarter-point rise in March could be the last in the U.S. cycle, said Bank of America economist Lorenzo Codogno, but euro-zone rates are lagging behind with some way still to climb. The European Central Bank raised its refinancing rate to 2.25 percent in December and has laid the groundwork for a further rise. The Bank of Japan may also begin tightening monetary policy soon.

Bigger risk premiums on commercial loans will amplify the impact of key rate hikes, Codogno said, and the higher borrowing costs will reduce buyout firms' leverage _ the amount of debt they can load up against a target company's income.

"There will be less appetite for risk in general," he added. "It will be more difficult to finance leveraged deals in a situation in which there will be less liquidity around."

Buyout houses are already paying top dollar, some observers say, for companies where the case for rapid improvement is not all that obvious _ like Neiman Marcus Group Inc., the U.S. retailer snapped up last May for $5.1 billion by Texas Pacific Group, Warburg Pincus and the private equity arm of Goldman Sachs, GS Capital Partners.

"The general view is that they paid a very full price," KPMG's Austin said, for a business that "wasn't badly run." With suitable targets in short supply, and both interest rates and stock markets poised to rise, "private equity houses are going to have to work much harder to get the returns they need," he added. "We might have reached a sort of leveling-off."

But if clouds are gathering for the buyout brokers, they are still well over the horizon.

Europe will remain a fertile ground for dealmaking in years to come, according to investment banker Pereira, as industries continue to digest relatively recent deregulation. Globally, he sees private equity activity increasing further in 2006 but accounting for a smaller share of overall M&A than last year's 14.9 percent _ based on Thomson data.

Private Equity Intelligence predicts that fundraising will stay close to its 2005 high. If dealmaking were to tail off then fundraising would follow, and buyout firms might not spend some of the billions already committed, said Nick Arnott, the research house's managing director. "But there's certainly no sign of that at the moment."

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Associated Press investigative researcher Randy Herschaft contributed to this report.