Friday Letter It's back but it's different

Ask a dozen US and European private equity and leveraged finance professionals if credit markets are open again and you'll get 15 different answers. But all agree conditions have vastly improved from 2009 lows.  

The fact that a $4 billion deal story hit the wires this week may have something to do with renewed optimism about credit markets. 

The LBO in question of course was the Carlyle Group's $3.8 billion offer to delist US vitamin company NBTY. One of the largest buyouts agreed this year, the deal includes a financing package of undisclosed size from BofA Merrill Lynch, Barclays Capital and Credit Suisse.

Carlyle's offer for NBTY represents an 8.15x EBITDA purchase price multiple, in line with an 8.35x average so far this year for big LBOs, as Standard & Poor's noted in a NBTY-focused leveraged commentary and data update Thursday. The update pointed out that compared to the 10.2x EBITDA multiple associated with the $1.65 billion buyout of GNC, a similar company Apollo sold in 2006 to Ares Management and Teachers' Private Capital, “the leveraged loan market remains far from the swashbuckling heights of 2006/2007”.

Still, says one US banking source, even if leverage levels are generally lower, “there has been a ton of LBO activity this year” that has included significant bank debt and mezzanine tranches. As an example at the top end, the source pointed to the $3.4 billion Interactive Data Corporation buyout agreed in May by Silver Lake Partners and Warburg Pincus. The deal has a $2 billion debt package, $1.3 billion of which is coming from many of the same banks backing the NBTY transaction: BofA Merrill Lynch, Barclays, Credit Suisse and UBS.

“Deals are getting done and arrangers are committing,” the source affirmed.

A survey of 20 major financial institutions released this week by the US Federal Reserve also found senior credit terms had become “somewhat more favourable” for private investment funds in the past three months. It found a “small fraction” of respondents easing price terms including financing rates, while one quarter said they had eased non-price terms like covenants, cure periods and cross-default provisions.

The situation is not exactly the same across the Atlantic, according to European GPs and banking sources. “What's clear is the banks are now back in business again and that probably has created a feeling that we're going back to normal – but we're not,” said a London-based GP. “Terms are still pretty strong. And ultimately banks are being much, more picky about the type of asset they are being asked to back and the financial sponsor.”

The overriding view in Europe is that things are improving but much more slowly than in the US. “The banks have got the appetite for debt but they are under inevitable capital constraints still,” explains one UK-based leveraged finance lawyer. “Leverage multiples are down to around 4.5x to 5x, debt to equity ratios are round about 50:50.”

But transactions in certain sectors, such as healthcare, are clearly being regarded more favourably than others. Bridgepoint's Care UK deal, a healthcare industry take-private agreed earlier this year, is one such example. In addition to supplying an equity cheque of around £200 million, the European private equity firm raised £210 million in senior loans as well as £250 million in an oversubscribed high yield bond offering that priced at par on Thursday. Part of the initial transaction's structure (as opposed to a defensive financing mechanism), Care UK's successful bond offering could indicate Europe's high yield market is opening up as another positive source of liquidity for certain sectors and assets.

While conditions are nowhere near the frothy environments experienced in the US and Europe pre-credit crunch, it's clear that debt market momentum is building back up from crunch-period lows, even if more slowly in some regions and sectors than others. That is going to provide important impetus to GPs’ ability to start executing deals, something many will celebrate.

But it will also draw into sharper focus the debate that these managers will have with their limited partners. This latter group remain intent on preserving discipline when it comes to pricing and leverage that some deal-starved GPs may find markedly more burdensome now that the credit markets have thawed.

Is credit back? Yes, with provisos. Is that a good thing? Yes, with provisos.