Exits: LBOs favour recaps

Private equity houses seeking divestment from European leveraged buyouts in 2004 are favouring recapitalisations or secondary buyout transactions, according to ratings agency Fitch.

Historically, trade sales and IPOs have been the traditional exits routes for LBO transactions. However with a deterioration of the capital markets and trade buyers who were no longer able to either leverage off their own balance sheets or raise additional equity to fund acquisition activity, PE houses have been forced to come up with more creative ways to crystallise their investments as they sought to return funds to their investors.

According to Fitch, a recycling of LBO transactions is being driven by high levels of uninvested cash in the private equity sector and a market convention that accepts a lower equity contribution in a recycled transaction thereby facilitating a potentially enhanced IRR for private equity firms.

Recycled transactions are also quicker, easier and cheaper to arrange compared to flotations and there is also a reduced execution risk for private equity houses. A partial or full exit by way of a recapitalisation provides a far greater degree of certainty of exit than an IPO.

Market conditions for IPO issuance is more favourable than it has been for a number of years, but overall the IPO exit route has not proved a fruitful one for European LBO issuers, according to the Centre for Management Buy-Out Research. Even in 2000, when the IPO market was more active than it has been recently, just 5.6% of total exits from LBOs in Europe were achieved through IPOs.

And so investor appetite for recycled transactions remains strong and is reflective of the demand for leveraged paper currently being experienced in the European market. Such appetite is further fuelled by investor familiarity with the issuer in its previous incarnation.