PE sponsors, leveraged loan arrangers eye 4Q for return of take-private LBOs

Of the many themes in play across European financing markets this year, among the most notable is that buyout volume is running well below historic norms as sponsors opt to sit on dry powder and hold their assets for a little longer. The macro environment also remains tough for deal-making, but there are hopes that an increase in take-private transactions will offer a way back to higher buyout volume overall.

“We think Q4 will be busier and we are all expecting it — both lenders and sponsors — so it might even become a self-fulfilling prophecy,” one lender said, clearly eyeing a pick-up later in the year.

Market players across the board also suggest M&A activity is generally resilient, and a reversion to a normalized level of activity is expected. But the combined impact of the various shocks to the system over the past couple of years has left an air of uncertainty, with the Covid pandemic, Russia’s invasion of Ukraine, inflation reaching long-time highs, and rises in interest rates all putting a massive strain on sponsors’ ability to make deals.

Volume dial
European LBO transaction volume (reflecting total sources of funding) totals €17.8 billion for the 12 months through the end of April, according to LCD data. This is a far lower figure than the €38.1 billion recorded in 2022.

LBO transaction volume was a far more robust €96 billion in 2021 as markets recovered from the first Covid waves, and sources hope activity could increase again as macro headwinds abate. Buyout volume is running well behind historical norms, and below the €55 billion average yearly LBO transaction volume from 2014 to 2021, according to LCD. “I would have expected deal-flow to have picked up already, but with the SVB and Credit Suisse debacle, that pick-up in deal activity has been postponed to September,” said Tom Whelan, partner at McDermott, Will and Emery.

“I don’t think central bank interest rates have yet peaked, here in the UK at least. If sponsors believe they have peaked and there is likely to be a decrease over time, this should give more confidence to sponsors that as debt costs go down that equity returns should go up — and may encourage more borrowing,” he added.

Sponsors are stepping away from debt in some cases, and 37.8% of deals in the 12 months to April 30, 2023 were made on an equity basis, while a further 37.3% of deals were funded through senior debt in the syndicated market. “LBOs depend on leverage,” says Whelan. “With the current lack of debt availability and hardening debt terms, we have seen a lot of sponsor clients looking to do all-equity deals with the intention of refinancing later when the debt markets improve.”

Similarly in the direct lending market, Inflexion's acquisition of Nomentia is supported by financing from Bridgepoint Credit and Sixth Street. Inflexion initially made the deal an all-equity transaction, and the financing includes a unitranche facility levered at 6x Nomentia's €14 million EBITDA.

Opportunity knocks
In 2022, 24% of all syndicated buyout deals came as take-privates, or P2Ps (public-to-private deals) as tracked by LCD's data — thereby signaling increased sponsor focus on the public markets for targets. What's more, a potential frenzy of sponsor-led takeovers this year for UK-listed firms could now lead a revival in overall buyout volume, investors say.

“After turmoil in the market triggered by economic uncertainty over the last year, we are left with a number of businesses that are fundamentally very healthy, with great products or outstanding innovation, but starved of capital. And their valuations have now slipped to a point where there is a fantastic value buying opportunity in the market,” says Mike Preston, partner at law firm Cleary Gottlieb Steen & Hamilton.

Among the biggest take-private deals in the UK market is EQT’s pitch to buy Dechra Pharma for £4.6 billion.

“Take-private deals will be hot for the next 6-12 months, focused on FTSE 250 companies,” Preston added. The increased proportion of P2Ps in 2022 followed an 11% share on this measure in 2021, while on average between 2012 and 2022, such deals accounted for a 13% slice of all buyouts — suggesting there could be a big jump in take-private deals to come.

“With fewer auction processes for private deals, there is always the opportunity for private equity sponsors to acquire a great company on the public markets at a relatively low price (as compared to prices a year to 18 months ago) if the shareholders are willing to accept the price offered,” said Whelan.

Currently in the forward calendar — which reflects deals that are mandated but not yet launched to the syndicated market — take-privates by Caverion and Software AG total €1.6 billion of expected debt to investors.

There were also a few P2Ps in the UK direct lending market recently, including the acquisition of social housing energy services provider Sureserve by Cap10 Partners, for which Pemberton acted as lender, and the acquisition of UK-based events organizer Hyve by Providence and Searchlight (supported by Hayfin, and Deutsche Bank's direct lending arm).

Also in the UK, Medica Group has agreed a £269 million takeover by IK Investment Partners. Under this deal, accepting shareholders of the London-listed provider of teleradiology and imaging services will get 212 pence in cash for each share held. The price represents a 32.5% premium to the company's closing price of 160 pence on May 19. Barings arranged the financing in this case.

Fundraising squeeze
Meanwhile, the fundraising environment continues to remain challenging for private equity firms, and market sources aren’t hopeful the situation will improve this year, with LCD in April reporting on a squeeze in the private debt market.

Some 22 private equity buyout funds have raised a total of €34.5 billion this year to the end of April, according to PitchBook, and matching the high of 152 funds for €95.9 billion in full-year 2021 would be a tall order. Sources suggest a fall in public market valuations over the last year or so and a contraction in the availability of leveraged loans have impacted LPs' ability to invest in new managers — mainly because GPs have not returned the capital to LPs at the same pace they had in the past.

“LPs today are focused predominately on re-ups, and they have less for new managers due to slower than expected distributions,” said Alexander Odysseos, director of the Private Funds Group at Houlihan Lokey. He added that private equity funds are taking longer to raise, and it has become increasingly common to see managers requesting fundraising extensions. Odysseos added that certain firms are also revising their fundraising targets amid the volatility. “The current fundraising landscape looks dramatically different when compared with 2018,” he notes.

Geography lessons
It's no secret that deal-making has made a slow start this year, due to rising interest rates and other economic concerns, which has also led to a markdown in valuations for assets.

That dynamic is also demonstrated by LCD's sponsored loan volume by geography data, which shows the UK — which used to lead such metrics — is now further down the table, representing just 9.3% of sponsored volume so far this year. This is largely due to weak economic performance over the past few years in the UK, coupled with inflation woes and fears of an impending recession. “I would say M&A is slowly picking up, apart from in the UK which has the highest inflation rate at the moment,” one lender said.

Elsewhere, in regions such as the DACH market, the general pace of deal-making is also expected to pick up going forward, according to Robert von Finckenstein, managing partner and head of debt advisory and restructuring at Alantra Germany. “In the last five years in the DACH region, about 100 assets have been purchased. They now need to be recycled, find a new home and show returns to the funds,” he said, adding that with Covid in the rear-view mirror and amid hopes inflation has peaked, it is becoming a buyers' market.

Sector selector
In a changing environment, the sector appetite of investors is also shifting accordingly. Indeed, LCD's industry diversification data shows the previously most-favoured sectors — namely Healthcare and Computers & Electronics — no longer top the chart for European sponsored loan volume. The Services & Leasing segment leads with a 23.7% share of the total, while Chemicals comes second with 20.6%. Retail is third with a 10.4% slice, followed by Computers and Electronics with 8.4%.

Within the UK and Europe, one of the sectors that is expected to show more demand over the longer term is energy transition, according to Preston at Cleary Gottlieb Steen & Hamilton. “Tech (including in energy transition), life sciences and infrastructure will all outperform,” he added. 

Rounding up the analysis with key sectors in the DACH region, these include software, business services, and industrial automation, according to Alantra's von Finckenstein.

Featured image by Kitreel/Shutterstock

This article originally appeared on PitchBook News