Private equity may be taking its lumps from Republican presidential candidates trying to derail former Bain Capital chief Mitt Romney’s nomination bid, but sponsor activity has continued unabated. Indeed, despite difficult conditions in the credit markets, private equity firms quietly inked $35 billion of new leveraged buyouts in the fourth quarter, the most in four-years, according to the LCD team at S&P Capital IQ, up from $22.5 billion between July and September.
That pushed LBO activity up a muscular 40.5% for all of 2011, to $111 billion from $79 billion in 2010.
Looking ahead, though, the outlook for new activity has dimmed because of financial conditions, not political consideration. Participants expect a flat year of LBO deal making, at best. And, if the European situation worsens, volume could track lower.
The reasons are fourfold. First, the summer chill brought on a less deal-friendly environment. Some stats:
In the fourth quarter, the average purchase multiple rose half a turn, to 9.1x, among large LBOs – those for issuers with at least $50 million of EBITDA – even as debt multiples eased to 5.1x, from 5.3x. Sponsors bridged the gap, pushing the average LBO equity contribution to 42% in the fourth quarter, from 35% during the first nine months of the year. As equity contribution increase, potential sponsor returns by definition decline and, thus, fewer deals are able to clear hurdle rates. Carlyle Group and Hellman & Friedman’s $3.9 billion fourth quarter LBO of Pharmaceutical Product Development is a recent example. The sponsors kicked in $1.76 billion of equity, according to public filings, or 45%, with the balance financed with a $1.3 billion loan and a $700 million bridge loan to a high-yield bond offering.
The second break on LBO volume is reticence among leveraged-finance underwriters after the August-September market downturn, which forced dealers to sell some new issue loans and bonds at steeper-than-expected-discounts. For this reason, inking public-to-private deals with long lead times is more challenging than it was in early 2011 when liquidity was flowing.
The third holdup for LBOs is the oft-mentioned uncertainty surrounding , which has made projecting cash flows a tricky business.
Finally, players say cash-rich strategic buyers are formidable competitors for properties. These corporate buyers can often outbid PE firms on the strength of (1) their low funding costs, (2) their typically lower investment hurdle rates, and (3) their ability to create – or at least imagine – synergies.
With all of this in mind, it’s no wonder leveraged finance players expect the volume of large LBOs – particularly those of the public-to-private variety or that require regulatory approval – to be limited in the near term, with PE firms focusing instead on middle market deals and tuck-in acquisitions in which synergies are possible.
The trend is clear in the forward calendar numbers. At year end, S&P Capital IQ’s LCD team tracked just $5.1 billion of visible leveraged loans in the offing, the lowest amount in two years.