Banks keen to lend, but buyouts elusive

Banks are increasingly aggressive about providing capital for leveraged buyouts and refinancings, but despite the availability of credit, large leveraged buyouts remain elusive.

While debt markets have recovered from the credit crisis, LBO size is typically in the USD 1 billion to USD 3 billion range, far below the double-digit billion dollar deals struck during 2005-2007. That is despite banks' willingness to provide capital for deals.

"It feels like we're in a market where (debt is) not the constraint," said Mark Epley, co-global head of sponsors at Nomura, speaking at Reuters' Global M&A Summit in New York this week.

Private equity firms "almost have to be prudent about how much they accept because the banks are perhaps excessively willing to provide capital."

Leveraged lending for the first quarter of 2011 in the US rose 92% from the same period the previous year, while overall US loan issuance was up 123% at USD 375 billion, figures from Thomson Reuters LPC show.

"I have been astonished by the US, the speed with which the (debt) market has come back there," said Michael Queen, chief executive at 3i, speaking in London. "I can only believe that is a temporary phenomena driven by the fact that the U.S. government is hosing money into the system and people are searching for yield."

Despite the increased availability of debt, U.S.-targeted LBO activity in the first quarter only captured 6.1% of total U.S.-targeted M&A activity compared to 15% in the previous quarter, Thomson Reuters figures show. Among some of the larger deals was the USD 3 billion buyout of Emergency Medical Services.

While private equity firms have capital to spend and an ability to raise financing for deals, they are facing an absence of a lot of big willing sellers, an average pricing market, and an uncertain period, said Garrett Moran, chief operating officer of Blackstone Group's private equity unit.

Moran said he didn't foresee much change in the type of deals being struck, describing the recent private equity deal flow as being "relatively humdrum eclectic deal activities."

"We have spent a lot of our time in the last year on things that are relatively less visible," than large LBOs, said Moran.

Buyout firms have found themselves outbid in auctions for companies by so-called strategic bidders -- companies in the same sector as the target -- which are flush with cash and can pay more as they can extract cost savings from merging assets. They also have faced a difference of opinion between some sellers on what their company is worth.

Private equity firms have instead been striking smaller deals, buying companies from each other or searching for units of large conglomerates which are breaking up.

There is some hope that deal flow will pick up as optimism increases and companies become more willing sellers.

"Things are beginning to develop and there's a reasonable chance deal activity will pick up, although I do feel it will remain eclectic for the short term," said Stephen Zide, Managing Director at Bain Capital.

"There are a lot of things going on behind the scenes ... from a planting seeds perspective (and) some of that can come to fruition if the markets remain somewhat positive," said Zide.

John Coyle, head of Permira's New York office, said he expects companies to become more open to selling, and that buyers will feel better about taking on more risk as they become more optimistic about the world.

That is a change from must-do refinancings of the past few years where portfolio companies were under pressure to extend the maturities of their debt.

"It definitely feels like a market where issuers are being more opportunistic and a number of (the banks) are seeking market share and are willing to be aggressive on the terms they'll do a refinancing and the fees they charge," said Epley.

Looser financing terms such as payment-in-kind (PIK) toggles and covenant-lite have been creeping back with a number of recent deals incorporating the methods.

These terms, more advantageous to the private equity firms than the lenders, show that the balance of power between the issuer of the debt and the lending bank is shifting to the issuer.

Covenant-Lite agreements lack traditional restrictions on borrowers, while PIK toggles allow borrowers to pay interest either with cash or by issuing more bonds.

Private equity firms like such terms because it can give them more ability to nurse a company through a downturn. However, for the lender, the terms carry the risk of less eventual recovery in the event that a company fails.

"Undoubtedly, every private equity firm spends a lot more time going through downside scenarios than they would have a couple of years ago," said Permira's Coyle.

Refinancings dominated U.S. lending in the first quarter, figures from Thomson Reuters LPC show.

Michael Abraham, UBS's co-head financial sponsors group for EMEA, also pointed to an increase in dividend recapitalizations -- increasing debt on a firm in order to pay a dividend to investors -- particularly in the U.S.

Still, Coyle said banks are not taking the type of underwriting risk they took in 2006 and 2007.

"The terms are very good upon execution but the banks in general are still making sure that as an underwriting matter they have enough additional spread, fees, incremental terms that they can put back into the document, such that if the market changes they are more than amply protected," Coyle said. "That's a good thing."