Conditions for leveraged buyouts are set to worsen as insiders report that mezzanine players are shying away from deals.
Mezzanine debt, the saviour of the leveraged buyout since the onset of the global liquidity crisis last year, is reported to be drying up by sources within the debt community.
“In the last month or two, we have seen deals pulled because there is no mezzanine appetite for them,” said the head of leverage at an international bank.
Plugging the gap between senior debt and equity in the capital structure, mezzanine has enabled buyout firms to continue to do deals despite the contraction of debt packages offered by banks since the credit crunch.
Since mid-2007 mezzanine finance has been in strong demand. Dismissed for the preceding two years as an outdated product thanks to elongated senior debt packages and the emergence of second lien, it is now firmly back on the leveraged buyout menu.
Disaster then for buyout players as mezzanine houses are reporting to have reigned in their investing in recent weeks.
“Mezzanine houses have done an awful lot of transactions since the credit crunch but over the last six weeks they seem to have become much more conservative, much more picky, much more cautious,” said a banker.
A spell of mezzanine players retreating from the lending market would be seriously bad news for private equity firms. The one or one and a half turn of ebitda that has opened up on deals cannot be filled by more equity if decent returns are going to be maintained.
Quietness on the mezzanine front is, however, likely to be a temporary affair. Mezzanine players such as ICG, Indigo and European Capital have plenty of money to put to work and the attractiveness of the mezz space over the last twelve months has prompted new fundraisings.
In April 2008, for example, Partners Group closed a mezzanine fund on €447m. Last year Lehman announced a €1bn target for its mezzanine fund and AlpInvest Partners received a €2bn mezzanine mandate from pension funds ABP and PGGM last October.
The current let-up in mezzanine activity is likely to be the result of poor trading on some of the transactions mezzanine houses completed in Q4 2007 and Q1 2008, forcing them to take a step back for the moment, or become more selective. Poor trading at sponsors’ portfolio companies, of course, is an equally big headache for private equity firms.
A substantial proportion of the mezzanine on transactions is also provided by the banks themselves and their caution seems to ramp up daily.
The second and third tier lenders who began to get a foothold in the leverage loan market as the credit crunch took its toll on the larger banks, are also known to be retreating from mezzanine lending.
With mezzanine shying away, however temporarily, making acquisitions is going to be even harder for buyout firms. Perhaps even more worrying is the almost paralysing caution at play in the lending market and what that says about the state of some portfolio companies and the economic outlook for the times ahead.