After a 40% contraction in global buyout activity due to rising interest rates and bank’s reluctance of opening their money taps to fund debt financing, private equity funds have begun to rethink how large transactions are made.
Blackstone (BX.N’s acquisition of Emerson (EMR.N. Climate Technologies) business in the United States, and KKR (KKR.N’s purchase of April French insurance broker by KKR.N are two examples of the way that buyout houses have to go to private lenders to get deals.
The market for leveraged buyouts (LBOs) has seen a slowdown after a strong start in 2022. This is due to the increased costs of financing and lower valuations, along with the conflict in Ukraine.
Based on data from Refinitiv, the number of LBO transactions announced globally up to December 14th has fallen 23.3% compared with last year. However, the total value of transactions took a 40.4% drop.
Global dealmaking has dropped 37% to $3.66 Trillion so far in 2015, according to Dealogic data. This is after it reached an all-time high last year of $5.9 Trillion.
Uday Malhotra (Citi’s cohead of leveraged finance for Europe, Middle East, and Africa) stated that “the first quarter 2023 will be fairly slow in terms of M&A, financing, and so forth.”
He said that private equity funds have large amounts of dry powder and would be looking for ways to use some of this material by the second half next year.
According to Preqin data, buyout funds had more than $800 trillion of cash remaining to deploy by November.
Most private equity companies buy businesses with equity and debt. Banks will often take on the debt and sell it to outside investors.
However, banks have been forced to either sell their debt at steep discounts to investors or to keep it on the balance sheets to ensure that market conditions improve. This has created an opportunity to provide private credit to help fill this gap.
Nick Clark, Allen & Overy’s co-head for global leveraged finance said that private credit was “the story of the century for 2022” and possibly for the first two-thirds of 2023.
However, banks are beginning to rebuild their balance sheets by eliminating higher-risk loans from their books. Meanwhile, debt funds seem to be becoming more prudent in the face of an impending recession.
“Ticket sizes in the private sector will likely fall depending on what deal is made. John Empson is a partner at CVC and co-head for private credit. “As interest rates rise and credit spreads increase, businesses will be able to take on more leverage and the amount of debt will likely go down,” he said.
Empson is confident, however, that private credit will continue to be widely adopted. CVC raised $6.70 billion in direct lending funds, and CVC has now raised $6.3 billion.
The banks often point out that debt funds – also known as direct lenders – have higher fees and stricter documentation requirements, which are competitive advantages over the junk bond and syndicated loans markets.
Private credit is seen as part of the solution in a period when money is tight.
Daniel Rudnicki Schlumberger (head of EMEA Leveraged Finance, JPMorgan) stated that “I believe the term loan market and private credit markets tend to converge.”
We have sold some debt that we had to lenders and used the other for larger deals.
Blackstone reached a deal in October to buy a 55% share of Emerson’s Climate Technologies unit using $4.4 billion equity and $5.5 Billion of credit from banks and credit funds. This is a model for leveraged buyouts.
CVC’s April Group was acquired by KKR using equity. KKR plans to raise debt financing down the line, according to a source who knew the matter.
KKR did not comment.
Although banks are making strides in improving their balance sheets, the problem of debt is still a concern. This includes deals such as Elon Musk’s takeover via Twitter and CD&R’s $7 billion ($8.47 Billion) purchase of Morrisons supermarket chain.
Clark, Allen & Overy said that there are large syndicated transactions which could cause banks who have underwritten them a lot of headaches on their balance sheets for a long time.
He said, “This will affect their desire to be re-entered the underwriting marketplace until they have resolved these positions that hang over from 2022.”
There is some optimism, however. Investors are returning to the loan market while borrowers agree to higher interest rates.
Eduardo Trocha (co-head of EMEA Leveraged Finance Capital Markets, Credit Suisse) said that there are emerging indicators that the LBO financing market is recovering. He pointed to the rising price in secondary leveraged loans markets, which trade higher-risk loans.
He said that syndicated agreements “will be more appealing to sponsors” if pricing recovers.