Just look at the multiples Google and AOL are tossing at targets. The big boys like KKR aren’t having any difficulty getting covenant-lite loans put in place for their behemoth LBO offers. But downstream, middle market PE firms need more access to capital for deals as well, and the coming weeks will test the strength of the broader leveraged lending markets.
LBOs for deals like KKR’s Del Monte bid and the TPG/Leonard Green J Crew play have nearly $9 billion in covenant-lite loan deals set up. Barely more than a month into 2011, that outpaces all the covenant-lite loans that were marketed to investors during 2010 ($8 billion). This also puts into perspective lenders’ appetites for deals, as well as the growing power of borrowers in 2011.
But it’s a small window of opportunity. If investors eager to participate in the robust lending market are going to again be made widely amenable to covenant-lite lending, smaller PE firms have to move quickly.
Sources say that despite 2011’s deal boom coming off a hot December, soon M&A will start to slow in coming months as the same businesses that sought to make exits no later than 12/31/2010 recalibrate projections to set up a stronger trailing 12 months for potential deals at the end of this year.
Many middle market PE investors continue to develop platforms with tuck-in acquisitions they expected to complete last year—but add-on deals don’t fill out a portfolio. In 2010, private equity buyers had the expected sunsetting of President Bush’s tax cuts for capital gains rates plowing a surge of sellers toward them—until, of course, sellers no longer needed to sell. That’s pushed last year’s sellers into 2011 and beyond, creating not just a glut of deals but an abundance of lending opportunities.
“I’ve seen a lot of spill-over of deals that were supposed to close in 2011,” said Randy Schwartzman, a tax partner with BDO in New York.
According to Thomson Reuters figures, last month strategic M&A in the U.S. surged 299% compared to January 2010, to $167.7 billion. PE activity grew as well, both domestically and abroad, our data shows. Globally, strategic M&A grew at a greater rate than PE deals grew, comparing each of the last two Januaries.
Regardless of whether we’re in a new lending bubble, private equity firms will need to take advantage of their opportunity to get better terms from lenders.
Will we get near the $100 billion in covenant-lite deals that 2007 created (that would later stoke default-domino scenarios not too long after)? Nope, absolutely not. There’s no guarantee that J Crew’s or Del Monte’s buyouts will even be completed, as a matter of fact. And there are hardly any CLOs remaining to fuel LBOs the way there were four years ago. It’s time for middle market PE firms to mimic the boldface names in the game. What’s the worst that could happen? You just have to keep borrowing on the same terms.