Surge in buy-outs puts focus on banks

Strain your ears a little and you might be able to hear a faint echo of the buy-out boom of 2007.

With interest rates low and private equity in a hurry to deploy more than $800bn (£527bn) of cash, the pace of dealmaking among buy-out firms appears to be increasing. During the past few weeks, a slew of deals has hit traders’ screens, prompting talk of a resurgence in bank lending to finance them.

That was evident in Carlyle Group’s $3.8bn acquisition of NBTY, the US manufacturer and retailer of nutritional supplements, which is being financed with $1.4bn of equity from Carlyle’s $13.7bn US buy-out fund and about $2.4bn of loans provided by Bank of America Merrill Lynch.

That means the deal is being financed with 63 per cent debt and roughly 37 per cent equity. While that may not be as high as the 80:20 debt-to-equity ratio commonly used during the credit bubble, it does show that banks are prepared to take some underwriting risk again.

Until recently, most banks had been reluctant to underwrite the financing for leveraged buy-outs for fear of being left with additional exposure. Citigroup clearly demonstrates the perils of deals done at the peak of the credit bubble, with a high debt burden and a volatile performance crippling the business. The US bank is still holding more than £2bn of EMI debt, after financing Terra Firma’s buy-out of the British music company in 2007.

These are painful memories of the buy-out binge, but they are unlikely to stop the banks from repeating the cycle just as soon as they are able to. After all, industry observers said high levels of leverage would never return following the collapse of the junk bond market in the 1980s.

Now, one of the biggest tests of just how much appetite for risk banks have at the moment will be the putative takeover of Abertis, the Spanish motorway operator.

The Spanish private equity market has been turbulent, to say the least, as a string of heavily indebted buy-out deals have required a renegotiation of finances in the wake of the Iberian economic downturn.

One example is Levantina, the maker of marble tiles and granite kitchen worktops, which was bought for €540m (£458m) by Charterhouse Capital of the UK and Impala of Spain four years ago. While its natural stone products are sold in 60 countries, Levantina has been hit hard by the economic downturn, particularly by the housing market slump in the US and Spain, two of its biggest markets.

Another victim of the Spanish recession is Panrico, the Barcelona-based donut chain bought by Apax Partners of the UK for €900m five years ago. While Panrico says the Spanish eat 19 of its donuts per second, its sales have fallen during the downturn.

In spite of these difficulties, a consortium comprising CVC, the buy-out firm, and two controlling shareholders in Abertis needs €5.3bn in bank financing to complete the takeover of the motorway operator, and is in talks with 15 banks about the loan, which was recently reduced from €8bn.

The deal is worth roughly €25bn, including about €13bn of debt, and if the consortium can get the money together, this will be the biggest private equity leveraged buy-out since things went pear-shaped three years ago.

Optimistic bankers say finding €4bn of equity should not be too challenging for the buyers, and raising roughly €8bn also seems achievable. Though Abertis’s current debt pile is worth almost six times earnings before interest, tax, depreciation and amortisation – a figure outside many banks’ comfort zones – the infrastructure group owns 65 assets, including stakes in toll operators, which it could easily sell.

If CVC pulls off the deal, it will be a clear signal to its rivals that the market is open for business and that the amount of debt being included is starting to creep upwards. After all, the less debt there is in a deal, the lower the profits for investors when it comes time to realising the investment.

Private equity was meant to be a high-risk asset class that promised to generate comfortable, double-digit annual returns, convincing investors to tie up their money in illiquid investments for at least a decade.

But the financial crisis and gloomy economic conditions have affected the performance of the industry. Recent research published in June by Coller Capital, the world’s biggest investor in second-hand private equity interests, shows that more than half of the investors in private equity who were surveyed saw their annual net returns from the asset class fall to 10 per cent or less as the financial crisis took hold.

The number of investors in private equity making net annual returns of 10 per cent or less since they started investing in the asset class has increased from roughly a fifth two years ago to slightly more than half this year.

Two years ago, more than 40 per cent of investors told Coller they had made more than 16 per cent annual returns from private equity. But this year only slightly more than 20 per cent of investors boasted of similar returns.

That should be incentive enough for both private equity and banks to go back to their old ways and start loading up their deals with as much debt as they can, as quickly as they can.

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