Swamping the mid markets

As this unhappy August drags on and the death of the “mega deals” becomes more of a surety, what effect will this have on the mid-markets?

With hedge funds exiting the market, CLO fund-raising ceasing and banks losing their CLO warehousing capacity, the lack of liquidity in the leveraged loan space means syndication of larger deals is now impossible.

A number of smaller deals, however, have won commitments through the summer, suggesting that the mid-market could be better equipped to adapt to the new situation (see financial markets p.14).

There is confidence that these deals are do-able – it is easier to sell a £20m ticket in a £200m deal, which only needs 10 banks to support it, than the same ticket on a £2bn deal.

But this does not mean plain sailing for mid-market funds going forward. With plenty of money still in the coffers the larger funds may well be forced to compete in this already highly competitive space.

It is of course standard cyclical behaviour for the big guys to dip downwards when larger deals become tougher to do. But the difference in this cycle is that the private equity industry has seen unprecedented growth over the last couple of years.

Fundraisings and subsequent deal sizes have grown phenomenally, so the already shaky practice of dipping downwards will be exacerbated. Even more worrying is that these mega funds are already beginning to state their intention to do smaller deals. Normally, this has been a silent practice.

Last week, Tony James, president of Blackstone Group said publicly that the private equity firm would be looking at smaller deals. This was a surprising admission from the largest global private equity firm, which has just closed the industry’s largest ever fund with US$21.7bn in capital commitments, at such an early and sensitive time in the current market conditions.

It is understandable that Blackstone might be trying to reassure investors’ in light of the current “credit crunch” that deals, even though smaller, can still be done.

But it must be very disquieting for the mid-market funds. Although the mega funds definition of smaller deals is probably still relatively large – the “upper mid-market” is already one of the most fiercely competitive spaces on the private equity landscape. How will this extra swamp of money effect their powers of deal doing?

Then there are the investors. It is fair to say that nowadays LPs are a lot more sophisticated and canny when it comes to private equity investing. They are careful about their allocations and subsequent exposures to the various different elements of the private equity space.

They most certainly didn’t sign up to Blackstone or any of its “mega” peers for mid-market exposure, so how will the presence of the mega funds in these deals affect the performance of their mid-market investments?

And what of Blackstone et al’s business model – there is no way that it can sustain the labour intensity of these smaller deals for much smaller returns.

Also in the case of Blackstone, 75% of its fund is actually already committed – it does not have a load of dry powder lying about with no home. If anything, it can just take its time now and perhaps delay the next fundraising rounds for a while.

On the upside – happy days for mid-market vendors!

Sandrine Bradley