It's an anecdotal tale that says much about the vastly scaled-down leveraged finance market in the UK (and, for the UK, read the rest of Europe and most of the rest of the world). The tale is of a casual exchange between two members of a London-based acquisition finance team. One turns to the other and says (imagine an ambitious glint in the eye): “I think we can be one of the top five or six debt providers in this market.” The colleague replies drily: “There are only five or six in this market.”
The slump in supply of debt supporting private equity deals has been as dramatic as it has been unsurprising given the decimation of many banks' balance sheets in the wake of the financial crisis. “Only the strongest deals will receive debt support. With no underwriting, however, smaller deals with fewer banks are much easier to complete all other things being equal. If you are doing a £20 million (€22 million; $30 million) deal and need £10 million of debt, you have a good chance of getting it,” says Nick Soper, head of debt advisory at Investec Bank in London. “One-bank deals, say £20 million or less, are easier to transact.”
Soper adds that the maximum commitment that one bank can typically make in mid-market deals is around £20 million and that for £40 million of debt “you need at least two banks, maybe three or four”. Towards the end of last year, Investec advised on the £52 million buyout of television production business RDF Media – a deal in which three banks provided £10 million each.
But, while it would be easy to dwell on the debt market's collapse, arguably the more interesting and encouraging story is that financing is still available for the right deal. Furthermore, amid increasing reports of the green shoots of economic recovery becoming visible (whether real or imagined), there are some signs of the flow of credit beginning to strengthen.
James Stewart, head of direct origination at UK mid-market buyout firm ECI, says his firm is among those to have found debt market conditions far from arid. “We have done four deals recently and we've had debt in all of them,” he says. “But lenders are very particular about the type of opportunity. It helps if companies are in a growing market, are resilient to downturn, have contractual revenue streams, solid asset backing and a good quality customer base in different markets.”
UNDER THE HAMMER
While the mega-buyouts of 2005 to 2007 are a receding memory, there are still competitive auctions of reasonably large businesses in which private equity firms are among the interested parties. For example, Dutch waste management business Essent Milieu is currently the subject of a sale expected to fetch between around €1 billion and €1.3 billion for which Credit Suisse and ING are reported to be arranging a staple financing package of between €400 million to €500 million. Private equity firms BC Partners, Charterhouse Capital Partners and PAI Partners have been cited in reports as having been shortlisted along with various trade and infrastructure entities.
Meanwhile the sale of Wood Mackenzie, a UK metals and energy consultancy owned by beleaguered buyout firm Candover, is not expected to suffer from a lack of financing options. “It's a very strong company and people will still want to pay a high for it,” speculated a market source. The business is thought to have received around 20 approaches and is expected to be valued at around £650 million.
For attractive deals such as these, the provision of debt finance is still in evidence. One trend that observers have noticed is for banks to concentrate their lending activities on their domestic markets rather than continuing to look at international markets. In the UK, many international banks have disappeared from the scene, although the likes of Royal Bank of Canada and France's Calyon are mentioned in dispatches as examples of non-UK banks that have continued to lend in the UK. In addition, Israel's Bank Leumi has been notably busy with its asset-based lending activities in the UK, as have other asset-based lenders. Furthermore, M&G, an investment arm of UK insurer Prudential, is reported to be raising a £3 billion fund for lending to UK mid-market businesses.
The most gaping funding gap for private equity deals has been created by the damage done to the balance sheets of many banks that were at the forefront of the leveraged finance boom. Because of this, lending levels will not return to the volumes of the recent past in the foreseeable future. However, as part of a push to get credit flowing again, certain nationalised banks – such as the Royal Bank of Scotland and Lloyds Banking Group in the UK – have been forced to resume lending to both individuals and businesses under the terms of a toxic asset insurance scheme. As a result, UK buyout professionals are expecting deal flow to steadily pick up during the course of 2009.
Another trend being seen is an increase in the availability of vendor loans. Notably, the £3 billion sale of exchange traded fund platform iShares to CVC Capital Partners – which was pending at the time of going to press – featured £2.1 billion in debt financing from vendor Barclays. Barclays said it would hold 51 percent of this financing for iShares' first five years as a standalone business and may syndicate the remaining 49 percent after a year.
And, even if you can't get the debt you want, there's always the all-equity option. Says Soper: “Some all-equity deals are happening in this environment where valuations, and hence entry prices, have fallen low enough to generate the returns. We don't see sponsors relying any more on debt refinancings but this could still be an upside somewhere down the line.”
Eventually, say market participants, the flow of acquisition finance will strengthen. In part, this is because margins and fees are now at a much higher level than they were during the boom years. “The question is, ‘is it all about confidence or do we have to wait to get through the economic downturn before we achieve any semblance of normality?’” says a market source. It's a rhetorical question – but there are some encouraging signs.