The LBO issue slips on the slowness of the buyout activity
Although LBO activity showed signs of recovery in the third quarter of 2020, funding declined year over year as the supply of new capital seeking LBO deals remained tight .
High Yield Bond and LBO leveraged loan issuance in North America and Western and Southern Europe increased from $ 26.4 billion in Q2 2020 to US $ 17.7 billion in the third quarter of 2020. Issuance for the first nine months of 2020 amounted to US $ 77.2 billion, down 32% from the US $ 113.2 billion recorded in the same period in 2019.
The decline was even more pronounced in Asia-Pacific (excluding Japan). The issuance of high yield bonds, leveraged loans and non-leveraged loans for LBOs has been down 74%, from $ 8.7 billion over the year until the end of the third quarter of 2019 to $ 2.3 billion over the corresponding period in 2020. There were no LBO issues in the region in the third quarter. quarter of the year.
The weakness of the mergers and acquisitions market weighs on the issue
Despite a good start to the year for LBO fundraising activity, including jumbo deals such as the finance package put in place for Advent and Cinven’s purchase of Thyssenkrupp Elevator, the market collapsed as sponsors financiers focused on portfolio management and suspended new buyout and exit activities. due to COVID-19.
The value of global private equity (PE) transactions, including exits, repurchases and secondary repurchases, increased from US $ 726 billion in the first nine months of 2019 to US $ 633.1 billion over the same period in 2020.
This has had a ripple effect for lenders, who still have an appetite to support LBO credits but have fewer business flows to choose from.
However, as a second wave of COVID-19 sets in, there is some hope that private equity firms will return to making deals – the global value of private equity deals has more than doubled. between the second and third quarters of 2020, from $ 122.8 billion in the second quarter of 2020 to 314 billion US dollars.
Buyout managers have adapted to the pursuit and execution of transactions from a distance, and the PE industry has also entered the crisis with large sums of money to deploy. According to Bain & Co, the PE industry had US $ 2.5 trillion in dry powder to invest in lockdowns, of which US $ 800 billion was for buyouts. Buyout firms can only delay signing deals for so long, suggesting that the recent upturn in PE deal activity still has room. This, in turn, should see the opportunities for leveraged financial lenders improve.
A high quality threshold
When buyout financing opportunities arose in the market, demand from lenders was strong.
Lenders are, however, increasingly selective about the quality and sector of credit. Investors clustered around higher-rated credits in privileged sectors such as tech and healthcare. This bifurcation, already evident before COVID-19, became even more pronounced during the disruption. About 90% of leveraged loan issuance in the United States this year, for example, was in credits rated B or higher.
Deals reflecting this trend include the buyout of Chinese online classifieds firm 58.com by a consortium including Warburg Pincus Asia, General Atlantic Singapore Fund and Ocean Link Partners, which was funded in part by a $ 2.5 loan. billions of dollars.
In the United States, Veritas Capital established a US $ 2.4 billion term loan and a US $ 400 million revolving credit facility to finance its acquisition of DXC Technology Corporation, and Francisco Partners raised a US $ 950 million high yield bond for its acquisition of cloud computing group LogMeIn.
In Europe, Permira recently obtained a loan of 670 million euros to finance its takeover of the pharmaceutical activity Neuraxpharm.
The repurchase credits that fall into this selected category were able to secure funding with relative ease, and do so on terms very consistent with what was available in the borrower-friendly pre-COVID-19 market. Prices, however, have widened, even for good credits. Pricing for European institutional leveraged loans averaged 531 basis points (bps) in the second quarter of 2020 and 461 bps in the third quarter. This compares to 408bp and 381bp in the corresponding quarters in 2019.
The doors to financing remain open
Given investor demand for yield, financial sponsors continue to seek to negotiate greater flexibility regarding covenants and EBITDA add-ons, including pushing, with some success, to add-ons that allow borrowers to recognize the cost savings and synergies expected from a deal before they are realized.
While lenders have been willing to agree to terms similar, or in some cases more favorable to borrowers as a whole, to what they offered in the pre-COVID-19 borrower-friendly market, some provisions have made it possible ‘subject to further scrutiny by lenders, especially those related to unaffected subsidiaries.
Before the pandemic, there were instances where borrowers were able to leverage additional leverage on assets and intellectual property held outside the credit pool, and therefore not subject to conditions and covenants. This flexibility of documents was used (or threatened to be used) more frequently during the pandemic, as borrowers sought access to additional capital in a struggling environment. As a result, more and more lenders have attempted to include in the documentation certain limitations regarding unlimited subsidiary flexibility in an attempt to prevent this practice. This means that in most cases lenders have refused to allow increases and in a number of cases have sought to tighten unlimited subsidiary flexibility.
Overall, however, sponsors seeking to finance firms of the requisite quality have found that leveraged financial markets are open and able to fund operations on terms that remain favorable to borrowers, although prices are declining. be expanded, even for good credits.