Volatile markets dampen US leveraged buyouts

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Buyouts slump to lowest level since 2003; concern grows over forward pipeline.

by Ben Edwards

The stock market panic at the start of the year rocked US share prices and sent company valuations tumbling – a potential boon for private-equity firms seeking to put cash to work at more palatable valuations. But there is a persistent problem sponsors are running up against: finding willing sellers.

"Sellers, whether private companies or public companies, are still adjusting to these new valuation levels, and that always takes some time, because everyone has one eye on the rear-view mirror," says Dhiren Shah, head of financial sponsors M&A at Credit Suisse in New York. "That tends to make it quite challenging for sellers to agree to deals based on current valuations when recent valuations have been quite a bit more attractive."

That backdrop has seen the number of US financial sponsor-backed buyouts slump to the slowest start to a year since 2003, with 121 deals either pending or completed by mid-March, compared with 150 a year ago, according to Dealogic. There has been a dearth of big deals too. Just four of those transactions are valued at more than $1 billion, Dealogic data show, though that doesn’t include Apollo’s $6.9 billion buyout of ADT agreed in February.

The lack of larger deals is partly because public debt markets have been cagier following a market rout at the end of last year when a number of banks were stuck with buyout bridge loans that they couldn’t sell to investors, raising concerns about whether sponsors are able to fund larger deals. But that shakiness has had little impact at the smaller end of the market. 

No problem

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Bela Szigethy, Riverside
Bela Szigethy, co-CEO at the Riverside Company, which specialises in mid-market transactions, says the growth in private debt funds means his firm has had no problem financing new deals.

"Banks in general have been tightening up and have in many cases fallen out of the market, but bank alternatives have stepped in to fill the void, and these lenders aren’t reliant on selling down," he says.

There are signs the public debt markets are thawing. Average US junk bond spreads – while around 150 basis points wider than a year ago – have eased back some 100bp from the wides seen in February, according to a Markit index. And deals are getting done. Petco, for instance, sold a $750 million bond in January – the first US LBO-related junk bond since September, Dealogic data show. And US LBO-related loan issuance bounced back in March, with Keurig Green Mountain raising more than $6 billion to finance JAB’s takeover of the coffee firm – a deal bankers had committed to last year when markets were more stressed.

"The financing markets seem in much better shape, but there’s still a backlog of transactions that were announced some time ago, and that backlog has a slightly dampening effect on new deals," says Shah, who expects most of the backlog to be cleared by the end of the second quarter.

Yet even as debt investors slowly return, a thin pipeline of potential buyouts at the larger end of the market is worrying deal makers.

"We have pretty good visibility 90 to 120 days out, because we’d already be working on deals that are coming to market in that timeframe, and there’s not enough," says a US financial sponsors banker. "There are a lot of reasons to be concerned about deal flow and activity. Our phone isn’t ringing off the hook with everybody asking us to finance deals. We’re out pitching business and I’m not seeing the level of enthusiasm that I would expect." 

Bankers say that means financial sponsors need to be more creative, given the scale of dry powder that funds need to put to work.

"Private equity in this environment sees opportunities to help companies in ways that don’t require a full buyout, such as helping them recapitalise or grow the firm if they don’t have access to the public markets," says Brad Coleman, global head of Citi’s alternative assets group.

In the Pipe line

One alternative way sponsors are deploying capital is through Pipe deals. A Pipe, or private investment in public equity, deal is one in which a public company raises money from a private party rather than on a public stock exchange. Silver Lake Partners, for example, made a $500 million investment into Symantec in February after a similar $1 billion Pipe into Motorola last year.

Other private-equity firms might take this lull in deal activity to focus on growing their portfolio companies and making them as successful as possible for an eventual exit, says Jennifer Perkins, global co-chair of Latham & Watkins’ private equity practice.

Those portfolio companies could become a source of deals if sponsors shake off their reluctance to participate in secondary buyouts, says Michael Walsh, co-head of global financial sponsors investment banking coverage at Deutsche Bank in New York.

"There’s plenty of evidence to show that secondary LBOs perform every bit as well as primary LBOs," Walsh says. "Sponsors are a little concerned sometimes about doing that, as there’s always a fear that the previous incumbent has squeezed all the juice out of the orange, but the analysis doesn’t support that view."

Large-scale corporate M&A might also be a source of deals as those companies are forced to divest assets to ensure the mergers meet regulatory approval. US drinks can-maker Ball’s purchase of Rexam, for instance, is dependent on at least $3 billion of asset sales before it can close with three private-equity firms and a strategic buyer among the bidders, according to a banker familiar with the auction.

"In volatile markets, you tend to see less traditional buyouts, as it is harder to get buyers and sellers to agree on price," says Coleman. "But if we see the markets stabilise, there’s tremendous liquidity in private-equity hands, and we’re seeing more and more liquidity in credit markets, and eventually people will be able to put their money to work."