Volatility Casts a Pall on European Exits

(IFR) – M&A may be the best exit option for private equity firms i n Europe this year, unless a prolonged period of market stability reopens another window for IPOs or investors become more willing to buy super-leveraged dividend deals.

A stellar first-quarter rally had boosted hopes of a return to so-called “dual-track” strategies for sponsors to run simultaneous public listing or sale exit strategies to generate the best returns on investments in portfolio companies.

The dramatic turnaround in market sentiment, however, means that private equity firms may not get that long-desired flexibility. Concerns are mounting that a window reopened for sponsor asset IPOs last month by Dutch cable company Ziggo has already slammed shut.

Sohail Malik, senior portfolio manager of European Credit Management’s special situations fund, said the first quarter may end up having been the best window of the year for IPOs.

On the other hand, bankers say, M&A prospects may not be completely hamstrung.

Several auctions are under way, and though deals are well down from the levels of a year ago, a thaw in debt capital markets has made more funding available at cheaper costs.

Some sponsors are sticking with the dual-track approach to give themselves more traction. Bridgepoint, for example, is running a dual-track sale and IPO launch for French eyewear retailer Alain Afflelou.

ECM’s Malik is also optimistic about M&A. He predicts a pick-up in risk appetite by corporate trade buyers, who have the advantage of being able to bypass debt capital markets to fund deals thanks to large cash piles.

“There are attractive targets in the leveraged loan and high-yield space that strategics are interested in. But although corporates have the cash on balance sheet to spend, they remain cautious on the size of targets as highlighted by the recent exit issues for ISS,” said Malik.

Danish services company ISS, owned by private firms EQT and Goldman Sachs Capital Partners, has ruled out a relaunch of its IPO plans until 2015 after a failed attempt last year and a pulled bid from security services firm G4S.

A third option for sponsors are dividend recaps, in which the proceeds from new high-yield bonds or leveraged loans are used to line the pockets of owners.

“The new player, the third leg of the stool, is the recap alternative. That only becomes available when debt markets become very robust, and they seem to be moving into that territory where investors are hungry and are looking for yield,” said Denis Coleman, European Head of Credit Finance at Goldman Sachs.

At least when they first emerge in a market cycle, recap deals usually come with less leverage and some price concession, but appetite for them in Europe is by no means as strong as in the States.

“People in the U.S. are more open to dividend recaps, whereas European investors tend to be a bit more disciplined about those use of proceeds. While we don’t think the floodgates will open, we expect to see more,” Coleman said.

Chris Munro, managing director of leveraged finance capital markets at JP Morgan, said IPOs and dividend deals are similar in that both need stable market conditions to be viable.

Volatility in markets, sparked by renewed concerns about eurozone growth prospects, ruled out high-yield primary activity this week, and anything riskier is likely to remain off the cards for now.

“A low-leveraged dividend deal for a performing credit is almost always possible,” Munro said.

“But what we have not seen in the European market in recent years are the super-aggressive recaps that take out all of the private equity stake.”

This year four European issuers have priced variations of dividend recaps — widely regarded as bull-market instruments — to take advantage of strong inflows into the asset class.

Two of those, Welltec and Nord Anglia, were sold into the dollar market, while Lowell Group Finance and Eco-Bat pulled off deals on this side of the Atlantic. Their common denominator is relatively low leverage.

William Healey, senior portfolio manager at JP Morgan Asset Management, said some dividend recaps can offer attractive yield pick-ups. Crucially, leverage should remain modest so that the future prospects of a listing are not hindered.

“If they’re done in a sensible way with strict covenants, and they’re not just a tool for private equity firms to cash in, dividend recaps can be a sensible thing for a sponsor to look at,” said Healey.

He is also optimistic about IPOs long-term, at least in terms of benefits for bondholders.

Ziggo has become the first “rising star” of 2012 following a lift to investment-grade status by both Moody’s and S&P in the wake of its IPO.

“Firstly, assuming the IPO is executed at the right price, it brings clarity about the size of the equity cushion that sits below the bonds,” said Healey.

“Secondly, it demonstrates that the company has access to equity markets and could return back to the market as an additional source of capital raising.”

(By Natalie Harrison)