With the end of cheap money, can private debt take over?
The multi-billion dollar sale of Britain’s biggest pharmacy chain was expected to be among the biggest private grabs backed by the UK EP in 2022, but it didn’t happen. The Boots deal named Apollo Global Management and Indian conglomerate Reliance Industries as potential buyers.
In a statement, parent company Walgreens Boots Alliance blamed buyers’ inability to raise funds in volatile market conditions created by the war in Ukraine and central bank monetary tightening.
This is a highly publicized example of dealmakers struggling to secure funding in the government debt market, and it is unlikely to be an isolated case. Indeed, the failure of the deal could be an indication that the era of cheap money, which fueled the most recent revival of private markets, is over.
Private debt funds, particularly in Europe, will want to fill the void left by the traditional leveraged loan market, but that might mean taking on more risk.
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Despite macroeconomic headwinds, private equity funds are still eyeing privatization opportunities. These types of trades provide an excellent opportunity for fund managers sitting on a veritable mountain of dry powder. Valuations are attractive in public markets, as falling stock prices create an advantageous target set for well-capitalized investors.
Privatization activity got off to a slow start in 2022. PitchBook’s Breakdown of Q1 2022 European PE shows that during the first three months of the year, only three equity investments were made – among which the takeovers of the British company Universe Group and CloudCall, which were closed in the first quarter – compared to 45 transactions of a total value of 44.8 billion euros (about 47 billion dollars) which closed in 2021, a record year for both the number and the value of transactions.
The problem for potential buyers is not a lack of opportunities, but a lack of financing for leveraged transactions available at attractive terms. As such, Europe’s heavily syndicated loan and bond markets are being undermined by private debt funds, which in the current environment offer an attractive low-cost alternative for negotiating the financing of large leveraged transactions. .
“We’ve seen the market shut down, particularly the high-yield bond and B-term loan market, but direct lending has been isolated to some degree,” said Floris Hovingh, London-based managing director of the investment bank Perella Weinberg Partners. “It’s partly because it’s capital locked. It doesn’t have a market price.”
According to Deloitte’s Alternative Lender Transaction Tracker, which tracks private debt transaction activity in Europe, there were 179 private debt transactions in the first quarter. Leveraged buyouts drove 41% of this activity, while M&As and refinances drove 27% and 16% of deals, respectively.
Not only does the deal pipeline remain strong, but deal sizes are becoming larger than ever. Earlier this year, The Access Group, which is backed by Hg and TA Associates, received the largest ever unitranche installation in Europe. According to LCD, the company’s £3.5 billion (about $4.2 billion) debt financing consisted of a £2.3 billion unitranche tranche and an acquisition tranche. of £1.2 billion.
Like their private equity counterparts, private debt funds sit on a lot of dry powder. Data from PitchBook shows that private debt funds raised $191.2 billion in total last year, the most since 2017, leaving these lenders plenty of firepower to deploy in increasingly large deals. .
But reliance on private debt comes with new risks. European private lenders, with plenty of dry powder to deploy and competing for bigger funding, are already relying more on so-called cov-lite deals. It is essentially financing that comes with fewer requirements for the borrower, i.e. covenants, and fewer protections for the lender.
Additionally, cov-lite loans have persisted even though there is growing demand for private debt as their use has become an industry standard and is expected by borrowers.
“We have a lot more influence as a direct lender on the terms, and the price is going to go up 50 to 75 basis points, but in terms of cov-lite deals, I think the dam has burst and too many funds are now ready to do so,” Hovingh said.
And yet, this is arguably the worst time in the cycle for lenders to waive protections. If private debt funds are willing to give up guarantees to meet a demand for alternative sources of financing acquisitions, who else will take over when these guarantees are needed?
Featured image by Joey Schaeffer/PitchBook News