Outlook 2016: ‘It’s a borrowers’ market’

A burgeoning number of debt providers has increased competition, but offers private equity firms optionality and flexibility to invest throughout the cycle, says Investec’s Callum Bell.

Mergers and acquisitions have had a boom year across the globe, but that wouldn’t be obvious if you were judging purely by private equity activity, said Callum Bell, head of corporate and acquisition finance at Investec.

Bell, whose team provides clients, including private equity firms, with debt financing, called 2015 “a year of two halves”; a buoyant first half, and a second half markedly slowed following the China stock market correction in the start of the third quarter.

High entry multiples in the market have been a deterrent for private equity funds to invest, with most players in the European market focusing on taking advantage of a stellar exit environment. High pricing has been influenced by the increased availability of debt.

“Pricing has remained relatively stable and widened from the lows of the mid-year, but what we have seen is leverage ticking up [to] above five times on a senior debt only basis, which is close to the peaks of 2007,” Bell said.

“Behind the statistics, we’re seeing the fast erosion of terms, so whilst you’re probably getting the same yield, your underlying risk is increasing. This will impact the asset class when it comes to impairment levels required if there was a sharp correction over the next few years.”

For private equity firms looking to finance transactions, they’ll find their options have significantly multiplied in the last few years.

“There’s been a lot of new debt funds and CLO’s raised that have significant levels of capital to deploy, and banks are – for the right assets – highly competitive. It is a borrowers' market,” Bell said.

Although the increased number of players in the market means more competition for Investec, it is a good thing for the industry, providing “increased optionality for private equity throughout the cycle”.

“An increased number of both market participants and investment strategies can only be seen as a positive to preserve a level of economic activity,” Bell said. “We can’t afford things to grind to a halt as a progressive economic society just because the outlook changes. Flexibility and optionality is important.”

More competition will mean Investec may miss out on some attractive opportunities. In this environment, patience and selectivity are key, Bell said.

“Selectivity is the key thing for our franchise going into 2016, certainly as far as picking the right assets and clients to focus on,” he said. “We remain keen to deploy capital, and supporting our key relationships where we can with ideas, capital and advice.”

On the M&A side, Bell has seen momentum build into the last quarter of the year, sounding a note of optimism for increased activity in 2016. However, with pricing unlikely to cool off significantly, funds will need to be savvy about how they put capital to work.

“Some will really be feeling the pressure if they’ve had quite a light year with regards to investment activity, given the high multiples in the market. They do need to deploy. How they do that is a really good question.”

Bell expects to see a continued increase in buy-and-build transactions, corporate carve-outs and platform investments.

“I think the strategy is always very important in this type of environment because just throwing out 10 times money across a range of assets is likely to come back with very average returns,” he said.

“The interesting thing will be following where multiples go and also where private equity spends its money. The real challenge for PE is to find assets which they can make good risk adjusted returns through the cycle that meet their LP’s expectations.”