S&P Capital IQ-LCD published a report on the
largest LBO transactions of 2015. Some interesting observations include:
1)
Purchase Prices (as multiple of EBITDA):
increased a full turn in the LTM from 10.25X to 11.24X. This is a new high
eclipsing the pre-crisis 2007 record.
2)
Funded Debt (as multiple of EBITDA): relative
flat at around 6.5X. Regulatory security has depressed leverage levels.
3)
Equity Levels (as percentage of capitalization):
increased to 35% to compensate for higher prices and constrained leverage.
4)
Deal Size: unlike corporate acquirers were the
large deals (over $10B) have reached record levels, current LBOs are smaller in
size. The largest deal PetSmart is $8.9B. This is partly due to the absence of
larger Public-to-Private deals.
This presents a problem for PE. High prices, stagnate leverage
and high equity will hamper the IRR performance for current deals. PE is forced
to compete against not only corporate strategic acquirers, but also thousands
of PE firms flush with newly raised funds. The current level of PE dry powder
is $540B and growing. PE firms are being forced to deploy their capital into
more expensive deals.
Leverage levels, unlike in previous cycles, are unlikely to
loosen anytime soon. Regulators are still concerned with leveraged loan debt
levels exceeding 6X EBITDA. The 2015 Shared National Credit report
indicates a majority of the special mention credits (i.e. criticized) involve
leveraged loans. Specifically concerning to regulators is poor underwriting
represented by weak covenants, back-ended repayment terms, reliance on
refinancing, and inadequate collateral. It is understandable that banks driven
by shrinking net interest rate margins are attracted to higher risk leveraged
loans with their higher nominal returns. Underwriting such loans this late in
the credit cycle means credit losses are likely to increase-especially in
energy and leveraged loans.
All of this leads to lower expected fund returns. You can
see this reflected in lower stock prices of public PE firms like KKR
and Carlyle.
The August and November market corrections could slow corporate strategic
acquirers relative to PE. The tightening credit markets, however, will
complicate financing terms, pricing and availability. So, as the saying goes,
PE may find itself caught between the proverbial dog and a fire hydrant, which
means things, can get a little wet.
J
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