Sponsor Contributions Down; Multiples, Too

Sponsors had to put up only 32.6 percent of a deal’s value to finance a mid-market buyout in the first quarter, a sharp drop from the 43.8 percent they had to contribute in the busy fourth quarter of 2010, according to Standard & Poor’s Leveraged Commentary and Data. At the same time, sponsors could get a purchase price multiple of only 6.5x EBITDA, down from 8.4x EBITDA in the fourth quarter.

Mid-market sponsors put up just 2.4x EBITDA in the form of equity capital to close first quarter deals, down from nearly 4x in the fourth quarter, LCD said, defining the mid-market as target companies with less than $50 million of annual EBITDA. Senior lenders increased their contribution to the capital structure to 3.8x EBITA, from 3.6x in the preceding period.

This development comes at a time when billions of fresh cash from mutual funds and institutional investors is pouring into the high-yield market, as credit rates remain at historic lows and investors search desperately for returns on their cash. Meanwhile, lenders have spent the first quarter complaining about a dearth of dealflow to drive demand for loans.

In ordinary times, a lower sponsor contribution would be expected to lead to higher purchase price multiples, according to the conventional wisdom. But today, it is likely the slump in deal activity has led to this apparent distortion in supply and demand, said Robert Polenberg, a vice president at S&P LCD.

The dealflow drought is real, so the first-quarter tally is based on a very small number of financings, Polenberg told Buyouts. Thus, even though the numbers are accurate, they may reflect the unique factors affecting a small pool of deals.

Another factor is likely to be an unusually high degree of uncertainty about the market and the economy, Polenberg said. “Buyers and sellers are still pretty far apart,” he said. “Sellers want to sell on the promise of 2012 earnings, and buyers say that’s too opaque for them right now.”

Among other findings from the report: Mezzanine financing all but dried up in the fourth quarter. At 0.16x in the fourth quarter, the use of mezz was at an historic low for the LCD dataset, which extends back to 1997, even lower than the 0.65x use of sub-debt in the credit-starved 2009.

The situation was different, however, among large corporate buyouts, which LCD defines as companies with EBITDA above $50 million. While the equity contribution also dropped in that category, to 36.6 percent of deal value from 38.4 percent, the purchase price multiple held up, at 8.4x EBITDA, compared to 8.3x in the fourth quarter. Sponsors put up 3.4x EBITDA to close their deals, unchanged from the fourth quarter, while senior lenders provided 4.7x EBITDA, up from 4.2x. In that category as well, however, mezzanine financing was crushed, providing less than 0.11x contribution to the capital structure.