Turmoil brings opportunity

Not only will the €4.7bn senior debt for VNU be offered to US banks in the first instance, but the expected bond piece is also being run from the US high-yield desks of arrangers Deutsche Bank, ABN AMRO, Citigroup, and JPMorgan. Senior debt comprises a €4.15bn seven-year term loan and a €550m six-year revolver. The decision to syndicate the deal in the US is largely due to the fact that around three-quarters of VNU’s income is derived from its US operations.

The size of the deal will further obscure what so far has been an unnaturally quiet year in the European LBO space. Although sponsor-related loan issuance for the first quarter of 2006 looked relatively strong at US$70.244bn, according to figures from Thomson Financial, this figure is skewed by the fact that underlying jumbo deals such as Ineos and TDC are attributable to 2005 activity.

The relative weakness of the first quarter is more apparent in Q2’s numbers, where the first seven weeks have generated only US$9.693m of loan issuance. By way of comparison, 2005 generated US$46.579m, US$59.601m, US$44.694m and US$33.528m of issuance in its respective four quarters.

Moreover, as senior debt issuance is the most commonly used element in financial structures, it follows that a dip felt here is indicative of a greater drop off in the subordinated asset classes such as high-yield bonds. In fact, despite widely-voiced predictions that sponsor-related issuance was set to become a more significant part of the market in 2006, it seems that most of the high-yield activity so far has stemmed from speculative grade corporate activity or opportunistic refinancing.

The high-yield option has also been suffering on account of its fixed-rate status – less attractive in a rising rate environment – and the fact that alternative products such as mezzanine have gained favour with investors seeking more flexible call structures.

Merits of the various financing tools aside, one of the main sticking blocks for private equity bidders has been the recent strong bull run in the equity markets, the fragility of which has only really emerged in the last week. Even with large funds at their disposal and debt funding on tap, sponsors have been faced with increasing resistance from shareholders emboldened by rising valuations.

This has colluded to place sponsors in something of an impasse. While ebullient fundraising and the growth of the consortium approach has required sponsors to target larger prey, hence drawing them towards the public markets to identify suitable deal opportunities, sponsors remain tied to expectations of return multiples. The impact on returns associated with a hostile takeover environment means sponsors are far less likely to stay the course than corporate acquirers, leading to such high profile withdrawals as ITV, HMV, Mitchells & Butler, and Rentokil.

It is for this reason that the private equity industry may actually benefit from the extended equity correction of the past week, although the effect may not be immediate.

“In the short term, the correction doesn’t make too much difference,” said one European leveraged finance head. “It could take two to three weeks for a deal to close, by which time the markets could be in a different shape. However, the general reduction in risk appetite should help private equity get deals through and may lead to a pick-up in activity.”

More modest valuations are likely to make shareholders more amenable to sponsors’ advances, as suggested by Knight Vinke’s sudden thaw in the VNU deal. A second benefit of the volatility is that it will reduce the allure of the IPO – the effect of which can already be seen in the pulled debuts of CMC Markets and Sigma Capital.

This in turn could actually increase deal flow by rejuvenating the secondary LBO market, particularly as private equity investors take a medium-term view of value, compared with equity investors who are concerned with immediate returns.