The reported €40bn bid approach made recently by
With European debt markets now apparently able to underwrite €30bn–€40bn in one deal, ever-larger transactions are on the cards. But do factors such as the increase in debt capacity and the targeting of bigger companies signal a real shift in the outlook for private equity? Or is the market a bubble waiting to burst, with excessive levels of debt and too much money chasing too few assets?
Simon Tilley, a director in
While that increased capacity has been particularly visible in the mega deals, it has also been true in the mid-market, he says, with many mid-market firms targeting bigger companies. For example, firms such as
These larger deals have been driven by the development of an institutional debt market. The danger, believes Tilley, is when a US-style debt distribution approach pushes out the more relationship-based model of the UK and Europe. Longer-term partners can give the deal sponsors more stability and confidence, he argues.
Tilley says: “You can get maximum leverage by tapping into the institutional market, but you need a core of strong relationship banks at the centre who are prepared to hold on to a proportion of the debt and play a full role if things get challenging.”
Antoine Drean, managing partner of fundraising agent Triago, downplays claims that some kind of structural shift has occurred as a result of the huge expansion of private equity, the globalisation of the asset class and institutionalisation of the debt market.
He says: “In 2000, a lot of people were talking about a paradigm shift and that all went down the drain. I’m not saying that will happen to private equity, but there are currently too many people trying to do the same thing.”
Drean says that there is a fear among some longer-standing buyout investors at what they see as inflated prices being paid in the secondary market. He tells the recent story of a successful New York investor in private equity.
“He told me that one week he got a US$10m cheque from one buyout fund following an exit,” Drean says. “The next day he was asked by another fund for US$15m to help them buy the same company but at a much higher price, even though he knew the first fund had left it well managed.
“This investor was wondering why he should back this secondary buyout, which was going to leverage the company even more. The management had become fabulously wealthy, so would they still be hungry? The private equity managers had received huge carry, the lawyers and investment bank big fees, so what was he going to get out of all this?”
According to Drean, part of the problem is that many institutional investors have been attracted to private equity because of the stellar returns of recent years, and so pumped billions of dollars into the asset class, fuelling the need to do deals.
“But many of these new investors forget that the high returns were achieved by buying companies when prices were very low and selling when prices were high,” says Drean. He adds that today nobody is able to buy cheap.
“There are still some very good GPs doing a good job, but many are feeling increased pressure from LPs to make returns more quickly and they are finding there is less time to do deals,” says Drean.
Katharine Belsham, corporate strategy director at mezzanine provider
“This has led to a false sense of optimism and a number of deals done at high leverage levels will have to be refinanced unless those companies meet very ambitious growth targets,” says Belsham. “The question is will those deals be refinanced or will there be a credit crunch?”
She believes there will almost inevitably be one or more events, either economic or political, that will dampen the debt markets and lead to a less benign lending cycle. “At the moment, for example, there are concerns over the US economy and the weakening of the dollar against the pound,” she says.
Belsham believes that, with the huge sums raised, even if there are problems in the market, buyout houses will still be aiming to do deals. “But with leverage returning to more sensible levels, prices will come down,” she says.
Iain Kennedy, a partner at
“There’s no doubt that overall market returns will fall if economic factors are less benign, interest rates go up or there are some high-profile defaults resulting in a credit crunch,” says Kennedy, adding that the market is almost certainly at a high-water mark in terms of credit availability.
Despite the concerns over high valuations and leverage levels, there is also a recognition that the expansion of the market means individual defaults could be less damaging than in the past.
Dominic Ely, private equity director at
“Where an MBO failed, the one or two banks holding the debt could take a significant hit and become more cautious,” says Ely. “Today the situation is very different because the debt market is broad and deep, with hedge funds, specialist lenders, highly syndicated loans and structured products.”
This means that individual company failures are less likely to significantly affect market participants, he says, adding, however, that lending multiples have probably peaked. If there is pressure on multiples in the future, it might mean private equity houses have to put more equity into deals, Ely says.
Triago’s Antoine Drean predicts tougher times for many buyout funds when debt liquidity tightens. But he stresses that there is no “bubble” similar to that created by the dotcom euphoria of the turn of the millennium.
“It’s not like the dotcom crash when companies vanished, because here we’re talking about real companies with real assets and they’re not just going to disappear,” he says. “But it may mean some funds have to take some hits and return not two, or even three, times money but one or 1.5 times.”
For Iain Kennedy, the “wall of money” entering the market will target the “low-lying fruit”, in other words the companies that are easy to sell and just need a bit of polishing.
“They’re willing to pay top dollar for those companies, whereas we go for the quirkier, harder-to-understand companies that are not so easy to sell but that can be acquired at a good price and transformed,” he says.
Kennedy argues that origination skills will continue to be crucial in differentiating oneself from the competition. “If you wait until an investment bank is involved, then you’re in a difficult situation, where competition is higher and accessing information on the target company is harder – you don’t have the time to burrow deep,” he says.
Having good origination skills means a private equity house can identify opportunities before others, get comfortable with the company and its market, and face less competition in acquiring the asset.
In broader terms, Kennedy sees increasing opportunities not only in developing markets such as India and other parts of Asia, but nearer to home in France and Germany.
“The French and German economies are comparable to or bigger than the UK’s, but their private equity activity is only a fraction, so there will be more activity there in the future,” he says.
It seems possible that with interest rates on the rise and a less certain macroeconomic environment, the private equity market faces challenges in the coming year or two. On the other hand, many people in the market have been predicting an economic downturn for some time now.
“Problems are always predicted for ‘next year’ but so far it hasn’t happened,” says Daljit Singh, a partner at law firm Berwin Leighton Paisner.
He adds that deals keep getting done, prices rise and debt multiples do not fall. In fact, says Singh, the influx of billions of dollars into private equity is affecting the financial markets in significant ways.
For example, price-earnings multiples for private companies are greater than those for public companies. This is unusual because traditionally there is a premium on public companies because their shares can be more easily traded.
Singh says: “There is no shortage of debt or refinancing. The banks are desperate to get in on deals and, in some cases, the private equity houses are sending the term sheets to banks rather than the other way round.”
He adds that even if this environment were to change, the fact that many private equity houses now have distressed debt or turnaround funds would work in their favour. “If there are problems, there will also be opportunities for some funds,” says Singh.