Leveraged buy-outs were one of the big casualties of the credit crunch. Some might say they were one of the causes too. But 2010 saw the LBO make a comeback. Dealflow was patchy at times, but volumes were up on the previous year (around Eu33bn versus Eu15bn). And in the second half, banks showed a willingness to underwrite, something that had been largely missing from the market since it collapsed in mid-2007.
But having enjoyed a reversal of fortunes, the market is now beginning to worry certain participants who think it has come back too hard too fast. Disturbing signals seen at the end of last year include a subtle increase in leveraged multiples (they ticked up to more than four times senior debt to Ebitda from around 3-1/2 in 2009), a slight fall in the size of equity cheques in LBOs (Credit Suisse reckons they fell from 53.1% in 2009 to 49.8% in 2010), larger bank bidding groups, talk of dividend recaps and covenant-lite returning to the European market (they have already come back to the US market) and a lack of new primary deals.
Much of 2010’s supply was pass-the-parcel secondary or tertiary buy-outs, a fact that has persuaded many market participants that the most suitable companies have already been bought out. That means that banks and sponsors will have to start sizing up riskier opportunities.
With too many banks are chasing too few deals, terms will undoubtedly become racier. So far, private equity firms have turned down the more outlandish or aggressive debt packages that banks have submitted as part of their mandate bids. For example, Nordic Capital turned down a debt package involving senior and mezzanine debt financing of 5.8 times Ebitda in favour of a more conservative 4.5 times Ebitda all-senior loan financing for its acquisition of Britax Childcare in November last year.
But sooner or later, the pressure will tell on bankers and sponsors, and a poorly structured, highly levered deal will slip into the market and fail in syndication. Such an event would be very dangerous for the European sub-investment grade market — the last thing that needs to happen is for the market to slam shut again at a time when the Eu317bn wall of leveraged loans set to mature by 2014 is looming.