There was a brief period of sober rationality during the current central bank-facilitated, market reflation phase, when Private Equity shops decided they had no desire to chase artificially inflated valuations, especially since their currency – cash – did not benefit in the same was a strategic acquirors did, whose own stock had increased alongside that of the target company. After all, who can forget Apollo’s Leon Black speaking at the 2013 Milken Conference when he said that “this is an almost biblical opportunity to reap gains and sell,” adding that his private equity firm has been a net seller for the 15 months, and that they “are selling everything that is not nailed down.”
In retrospect, he should have hung on. Of course, who could possibly known that nearly a decade into the greatest central-planning experiment in history, central banks would still be injecting trillions into the market to create the illusion of economic growth, stability and a wealth effect, hoping to kick the can in perpetuity.
So, several years later, and scared of missing the boat altogether after sitting out a big part of the bubble, PE firms – flush with cash – are rushing in. In some ways, the PE willingness to resume buying companies at virtually any price is understandable: with the financial system overflowing with cash, much of it has found its way into the PE industry, and according to a recent Prequin survey, as of 2016, private equity funds were sitting on nearly $800 billion in cash.
And while we previously reported that the median LBO PE multiple has risen to 10.8x, the highest since the financial crisis…
… this has largely been a reason of the permissive bond market, because according to LeveragedLoan.com, in the third quarter of 2017 the total leverage on large U.S. LBOs rose to 6x, the highest it’s been since the financial market meltdown of 2007.
“Only 6x”, the more cynical readers might say? Well, as LCD reminds us, that 6x number is of particular interest to the global leveraged finance market. Some readers may recall that regulators, in an effort to shore up the financial system after the crisis, issued guidance in 2013 saying that loans with a debt/EBITA ratio in excess of 6x “raises concerns.” This prompted traditional corporate lenders – banks regulated by the Fed – to proceed cautiously regarding highly leveraged transactions, those near 6x or higher. This cautiousness, meanwhile, helped open up the direct lending/private credit market, where non-regulated asset managers increasingly are stepping in to provide often-riskier credits to leveraged borrowers.
Still, it’s mostly a bank-led markets. As LCD notes, while non-regulated lenders continue to make inroads into the leveraged lending space, most of the deals underlying the above chart are led by traditional banks, demonstrating that those entities continue to drive this market.
But the bigger news, if only to banks, is that a return in LBOs, which as we showed earlier this year had largely plateaued in 2014…
… would mean more, and higher fees: LBOs are especially attractive to loan arrangers and investors as they feature higher fees and interest rates than non-M&A credits, such as those backing refinancings or general corporate purposes. Indeed, according to LCD, these higher-yielding deals comprised a relatively large share of leveraged loan activity in Q3 2017. This is a marked change from the first half of the year, when repricing activity and other ‘opportunistic issuance’ dominated the U.S. loan space.
And while it is likely that this LBO bubble will have a similar end to the one in 2007, one thing is certain: for now – with HY spreads approaching all time lows – investors just can’t get enough debt, meaning that no matter who or what the issuer, or how much leverage is layered on, acquirors will have no problem at all in funding any and every going private transaction, which is why we expect that 6.0x total turn of debt to be fond memory the next time we refresh LBO statistics in a few short months.
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