As the 2011 began, lenders were convinced the need for middle market financings (defined as companies with EBITDA of less than $50.0 million), which started to increase during 2010, would accelerate and they would all be overwhelmed with increased demand for debt capital.
But as we talk to numerous financing providers, including senior lenders, finance companies, mezzanine funds, BDCs, and hedge funds, they all report a disappointing lack of activity. The deals they’re seeing tend to be of lower quality, leaving them with little to do except hope this trend reverses. Interestingly, this lack of deal flow is in stark contrast to the results of a survey of over 125 different lenders that Lincoln International undertook at the beginning of the year. Ninety percent of the respondents believed the volume of LBOs would be higher this year compared to last year, and 65% believed the number of dividend recaps would be greater in 2011 than last year.
Our experience as private placement agents seems to confirm this lull in activity. As part of our process, we contact lenders to gauge their interest in a credit and have them execute confidentiality agreements to obtain more detailed private placement materials. Normally, it takes some time for this process to unfold and for lenders to provide their feedback on a proposed transaction. However, we are noticing an astonishing 90% of all lenders we approach are expressing an eagerness to pursue our financings almost immediately after we contact them, and an unusually high number indicate they could be available within the week to travel to the company for management presentations. We pride ourselves in bringing high quality deals to market, but it’s hard to believe that almost all of the lenders we approach are ready to pounce on an opportunity unless there is a severe shortage of financings in the market.
We’re reluctant to speculate on the cause for this lackluster deal flow, particularly since the larger cap market continues to explode. Some suggest that companies are simply waiting to refinance or begin the sale process after they complete year-end audits. Others say the increase in commodity prices are reducing margins so many sellers are holding off until earnings rebound. Entrepreneurs are telling us that, with interest rates so low, they are happier keeping their capital in the business because there are no attractive alternative investments. Still other, more cynical folks, believe some private equity groups having trouble raising new funds would rather hold on to their investments and continue to collect management fees.
Regardless of the reasons for the current lull, we do believe that financing activity will pick up as the year progresses. Our M&A brethren are experiencing a dramatic increase in pitch activity, normally a reliable leading indicator to future M&A deal volume, and the number of deals hitting the market has already begun to grow.
The moral of the story – if you have a need for capital, whether in connection with a refinancing, acquisition, or dividend recap – access the credit market as soon as possible. Lenders need to put money to work and the current window may allow for higher leverage and lower pricing relative to any other time this year.
Ronald Kahn is a managing director with Lincoln International. The opinions expressed here are entirely his own.