Private equity firms, investors and middle-market companies are riding high right now, with an overwhelming majority discounting the chances of a U.S. recession in the next year. But lenders should remain cautious, said David Brackett, Antares Capital’s co-CEO and a managing partner.
Some 89 percent of middle-market companies and PE firms said in a survey they were “confident” or “very confident” about the U.S. economy in 2018. That’s up from 85 percent in 2017, Antares said. For LPs, 87 percent are enthused about the U.S. economy.
Asked about a recession, 83 percent of sponsors and 92 percent of LPs said a crisis was unlikely over the next 12 months.
Brackett, however, says such positivity could breed complacency. “This is the environment where you can make mistakes,” he said.
The Antares co-CEO said he lives with a view of the markets that is “always half full.”
Lenders like Antares are always expecting and preparing for a market correction, he said. “We’re always worried,” he said. “People ask us what inning we are in in the baseball game, and we’re always in the bottom of the ninth.”
Brackett said he’s concerned about leverage levels, which he said are creeping up. Purchase-price multiples are at a level he’s not seen before. Terms have become “far more loose,” with addbacks and adjustments becoming an increasing proportion of cash flow and EBITDA, he said.
Lenders, he said, must pick companies that can withstand turns in the economy. “The economy is like a road trip,” he said. “You have lots of twists and turns and have to proceed with caution.”
The Antares executive pointed out that it’s been 10 years since the last crisis. In March 2008, JP Morgan rescued Bear Stearns, which many consider the start of the financial crisis. Lehman Brothers went bankrupt later in 2008.
But many people in the current lending market, while they have good pedigrees, have little or no experience in the middle market and even fewer have been around through multiple credit cycles, he said. “There are people who didn’t live through a crisis,” Brackett said. “Living through a crisis is healthy.”
The second annual Antares Compass survey questioned 100 respondents in January.
More than three-quarters, or 77 percent, of the middle-market companies responding had EBITDA of $50 million or lower. Eighty-three percent of the PE sponsors questioned had a current fund size greater than $1 billion.
LPs that answered the survey came from backgrounds including banking, business-development company, collateralized loan obligations, insurance, non-bank lender or other. See the survey here.
In December, the Donald Trump administration pushed through an overhaul of the U.S. tax system. The bill cut the U.S. corporate tax rate to 21 percent form 35 percent. The Antares survey found that a majority of sponsors, or 88 percent, saw the new tax law as having little impact on aggregate LBO activity.
Brackett agrees with the survey results.
Under the new bill, companies can deduct interest expenses only up to 30 percent, which has caused some to fret about the impact on LBOs. Brackett expects positives imposed by the tax law — including capital expenditure credits, reduced overall tax levels and the ability to repatriate — to mute any impact from interest deductibility. “It’s a very positive tax-law change,” he said.
Action Item: Contact David Brackett at +1 (646) 880-5100
Photo of David Brackett courtesy of Antares