Talking Deal Prices: Middle-market lender sees softer covenant cushions

  • Madison Capital flags softer equity cushions in loans
  • High prices forcing some looser loan covenants
  • Beefing up origination staff as it works to avoid auctions

Madison Capital Funding executives said they’ve not seen a big return of covenant-lite loans in the middle-market-lending space.

But in a meeting with Buyouts, they said they’ve seen more frequent use of single-covenant loans, which include looser guidelines around EBITDA cushions.

In the wake of the 2008 financial crisis, financial-covenant cushions hovered around 15 percent to 20 percent, but they’ve since been loosened in many cases to as much as 30 percent to 35 percent.

The latter guideline means a company’s EBITDA could fall by as much as 35 percent before triggering any financial-covenant default, which often requires a company to reduce debt.

On the plus side, Madison Capital executives said second-quarter 2016 marked the first time in a while that purchase-price multiples in their universe fell. So pricing may be taking a step back in 2016.

On a separate note, Madison Capital is marking its 15th year in business this year. In a recent interview, the firm said its key metrics in weighing deals include a company’s free-cash-flow generation, cyclicality and industry trends. It’s also pivoting to provide more loans in the tech sector, along with its current focus on healthcare, insurance and financial services.

S&P notches drop in purchase-price multiples in Q2

While the runup in deal prices has forced some looser covenant restrictions on deals, the latest data shows a continued trend of somewhat restrained leverage compared with the peak years prior to 2008.

Looking back at the second quarter across U.S. buyouts, leverage levels actually fell to an average of 5.29x EBITDA in the second quarter, down from 5.35x EBITDA in the year-earlier period, according to S&P Global Market Intelligence.

Marina Lukatsky, director of leverage commentary at the S&P unit, said LBOs aren’t as loaded with debt nowadays. “In general, we’re not seeing as many aggressively structured buyouts in recent quarters as we have seen historically,” she said.

Whether U.S. LBO purchase prices have peaked or the drop is temporary remains to be seen. For some GPs and their caches of dry powder, lower prices would be a welcome sight, even if they come with more economic uncertainty.

Overall, the tone of the middle-market-lending environment remains a bit more cautious in 2016 compared with a year ago, even as credit markets quickly regained their footing after a Brexit-inspired hiccup in late June.

Stefan Shaffer, managing partner of SPP Capital Partners, said the market appears divided between intense interest in stronger deals and tighter lending standards for riskier deals.

“On the one hand, pricing has become intensely competitive for the best assets, but on the other hand, apprehension about future economic conditions continues to drive a more conservative credit environment overall,” Shaffer said in his August market update.

Soundcore cold-calls Baby Boomers to find deals

With double-digit purchase-price multiples common among sponsors, emerging manager Soundcore Capital Partners has set its sights on much lower levels.

Soundcore sifts for recession-proof businesses, learns about industry niches, and then reaches out to acquisition targets directly, often by cold-calling them.

Founded in 2015 by Sun Capital veteran Jarrett Turner, Soundcore managed to find deals with purchase-price multiples of about 5x EBITDA, with a maximum just below 6x EBITDA. That range of PPMs includes deals already completed by the firm plus others in its pipeline, a source said.

The firm puts its feelers out for Baby Boomers looking to cash out part or all of their business.

In Soundcore’s first platform deal late last year, it worked with the founder of Alloy Wheel Repair Specialists, Tom Morris, who retained a minority stake in the alloy-wheel-repair and -replacement company but stepped down as leader of the company.

In April, Alloy Wheel Repair said it closed four bolt-on acquisitions that serve 200 dealers and auto-repair shops.

Now, Soundcore is reportedly in the fundraising market with its first buyout fund, targeting $250 million.

The firm plans to beef up its deal-origination team by hiring as many as three more people. Efforts along this front will be aided by operating partners such as Bill Lasky, an industry veteran in the automotive sector, and Bill Berry, former CEO of American Tire Distributors.

While many GPs say they invest outside of auctions, Soundcore plans to stick to that thesis as it reaches out to LPs and entrepreneurs this year.

Action Item: Covenant-lite loans:

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