January 2, 2013 5:01 pm
This article is provided to FT.com readers by dealReporter—a news service focused on providing insightful intelligence on event driven situations to investors. www.dealreporter.com
There will be more leveraged buyouts in 2013, predicted several lending sources, but large deals will continue to be few and far between. These sources told dealReporter that financial sponsors can expect easy lending terms and still elevated equity levels in the New Year.
Tom Cole, co-head of leveraged finance at Citigroup, said he predicted at least one deal may top USD 10bn. The biggest pickup in activity, though, will be deals in the USD 1bn to USD 3bn range with perhaps 15 to 20 over USD 2bn, Cole told this news service.
On tap for 2013, Best Buy (NYSE:BBY) founder Richard Schulze is still trying to organize a group of financial sponsors and lenders to back a USD 5bn to USD 6bn bid to take the big box electronics retailer private. Schulze struggled this past fall with financing but now has until March to table an offer.
Another retailer, Advance Auto Parts (NYSE:AAP), explored a big leveraged buyout this fall, though talks with private equity firms reportedly broke down in November. The company was reportedly looking for a deal valued at around USD 6bn.
Boding well for future deals, the leveraged finance market is wide open for business, said a number of sources that work in the high yield space. Richard E. Farley, a partner in the corporate practice at Paul Hastings, said he sees the same robust capacity in financing markets as in 2006 and the first half of 2007.
Refinancing has been a dominant theme in high yield markets over the past 24 months, said Kevin Sterling, co-head of Leverage Finance Capital Markets at Goldman Sachs. While there is still more refinancing to accomplish in 2013, many firms looking to lock in lower interest rates have already done so, Sterling added.
The refinancing activity increased new issuance volume—2012 hit a record with around USD 300bn in total deals—but did not increase the overall supply of high yield debt in the market, said another investment banker. This may leave extra capacity for investors to buy up additional debt in 2013.
Institutional investors want to invest capital and banks have cleaned up their balance sheets, said a second investment banker. This demand has driven yields down 100bps over the past six months as investors pile into new offerings, said the banker.
A buyside high yield analyst said he expects the high yield market will have about a 5% return next year. New issuance will remain robust and M&A will be active, he said.
Along with high yield bonds, there is also a greater availability of bank debt, said Sterling and the first banker.
Spreads for loans are expected to tighten more than bonds, especially in 1Q13, Cole said. The loan market is roughly half the size of the USD 1.1 trillion bond market. For the last four years, the bond market expanded as the loan market shrunk, providing more opportunity for loan growth, he said.
Collateralized Loan Obligations (CLOs) have done well in past few months after blowing up in 2007, the first banker explained. This has helped the loan market as CLOs have purchased the bank debt, he said.
The market is on track for an estimated USD 54bn of CLO formation this year, higher than expected, Goldman Sachs’s Sterling said. This creates new buyers for the debt, supporting new issuance, he said.
With robust demand for debt, private equity firms have had ready access to so-called covenant-lite loans. Also helping financial sponsors, default rates on loans have been low, said the first banker.
Bank deals are coming with bond-like covenants, the first banker said, with the trend towards incurrence covenants and away from maintenance covenants.
The market has been receptive to covenant-lite transactions, Sterling agreed. This is driven in part by the supply and demand technicals as well as the credit quality of the issuers, he said.
Even with open debt markets, lenders continue to demand financial sponsors commit to providing relatively high equity checks, said the second banker. Private equity firms are expected to sign off on 30% to 40% equity checks depending on the sector, down from the 50% level during the financial crisis, he said. This range is still elevated compared to pre-crisis transactions.
If there is a deal with the “right” sponsor, a deal can get done with a 30% equity check, the same banker said. Lenders remain more conservative than they were in 2006 to 2007, he said.
The equity demands come as financial sponsors have less firepower to write checks to back large transactions, potentially limiting the ability of the market to back mega buyouts.
Many private equity firms are reluctant to form consortiums to back big deals since past group deals have proven difficult to manage, Citigroup’s Cole said.
Investors in private equity funds, limited partners, have also sometimes objected to large consortium deals, as the limited partners are looking for diversification of investments when placing funds with several different financial sponsors, said Farley. A consortium deal, conversely, can concentrate risk for an investor that has funds with multiple sponsors invested in the deal.
Financial buyers are also raising smaller funds, in the USD 5bn to USD 8bn range, rather than the USD 15bn funds that were previously seen, Cole said.
Sponsors have found it difficult to deploy the mega funds in their expected investing time frame of three to four years, Farley said. These private equity firms would rather raise smaller funds that can be more quickly deployed and raise another fund if needed, he added.
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