- Debt ratios for middle-market deals climb
- Demand from LPs for debt returns plays a role
- Volatility may signal change in cycle
While market volatility in recent weeks may signal trouble ahead, for now the frenzy for both broadly syndicated and middle-market loans is expected to continue.
A combination of cash-flush strategic buyers, rich valuations for publicly traded comps and easy debt continue to fuel purchase-price multiples. LPs seeking returns better than those from U.S. Treasurys allocate billions to high-yield debt.
“Because of all the capital that has flooded into this market — mostly large pension funds and sovereign-wealth funds from around the world — demand drives loan issuance by U.S. corporates,” Monroe Capital CEO Ted Koenig told Buyouts. “Such loan issuance has been at an all-time high in the last two years.”
Among larger deals, Blackstone Group made waves with its richest acquisition since the financial crisis when late last month it said it would buy a 55 percent stake in the Thomson Reuters Financial & Risk unit for $17 billion. Blackstone is set to finance the acquisition with roughly $14 billion of leveraged loans and high-yield debt, Bloomberg reports.
The deal values the data business at a lofty leverage ratio of about 8x annual earnings, according to Moody’s.
For the most part, you’re not going to see debt multiples like that in the middle market — at least not yet. But middle-market buyout loans, which had been spared from higher prices and debt levels, have been pulled higher by action in the syndicated-loan market.
Generally, PPMs in much of the middle market typically range from 8x Ebitda to 9x Ebitda on the low end and up to 13x to 14x on the high side nowadays, according to market participants.
Industrial and distribution companies command prices on the lower end. Higher multiples go to software and business-service companies or other companies with recurring revenue. The healthcare sector in particular remains very hot.
Monroe Capital’s Koenig argues that the upper end of the middle-market loan business more closely resembles the much larger syndicated loan market.
Historically, companies with Ebitda of more than $100 million regularly tapped the high-yield-bond market for senior debt. Now companies with as little as $50 million in Ebitda are high-yield eligible.
That has changed the game in large middle-market finance.
Firms that specialize in financing PE sponsor-led buyouts of companies with more than $50 million in Ebitda now have to compete head-to-head with the high-yield market, frequently offering seven-to-10-year fixed-rate, 5-percent-to-6-percent interest-only loans.
“It is very hard to generate any favorable risk-adjusted return in that area for private credit debt providers,” Koenig said.
With this type of leverage now available in the middle market, debt multiples in 2017 grew to more than 4x Ebitda and up to 5x on larger deals, according to Monroe’s estimates.
Until recently, debt multiples were typically below 4x for senior secured debt.
“Loftier purchase-price multiples coupled with higher levels of senior debt, no covenants and poor loan documentation is scary,” Koenig said. “When the cycle turns, this is a recipe for trouble.”
Last year, the middle-market leveraged-loan market was hot. M&A was very strong, purchase-price multiples were high, leveraged debt was cheap and interest rates were stable. Default rates also remained low.
While these factors contributed to a good deal-making environment, the numbers overall were hotter in 2017 even compared to the other recent years of frothy deal environments.
Monroe Capital closed 77 loans in 2017, up from 64 in 2016, and deployed $2.1 billion of new capital, the highest ever for the firm.
For now, Koenig expects 2018 to bring more of the same lofty price dynamics and high levels of deal activity.
“With the Trump tax cut providing faster write-offs for expenses and capex, as well as lower tax rates, companies will have more free cash flow,” Koenig said.
“Purchase prices will likely increase as strategic acquirers put their stronger balance sheets and high free cash balances to work in M&A. That should provide strong competition and tailwinds to PE.”
Action Item: Ted Koenig’s bio and contact page: http://www.monroecap.com/team/theodore-l-koenig
Photo of Ted Koenig courtesy of Monroe Capital