Buyout issue leads the way despite choppy M&A market | White & Case srl
Key points to remember
In the United States, redemptions totaling $235 billion were announced in the first half of 2022, well above pre-pandemic levels, year-over-year, dating back to 2007
Loan issuance for buyouts increased in the first half of the year, reaching US$94.5 billion
High-yield buyouts had a strong first quarter, hitting US$7.4 billion, before bond market activity waned in the second quarter
Lenders’ appetite for buyout opportunities in the United States remained resilient in the first half of 2022 despite a volatile macroeconomic backdrop and lower activity across the leveraged financial market.
The issuance of buyout loans took place at US$94.5 billion in the first half of 2022, up from the US$79 billion obtained in what was already considered a booming market in the first half of 2021.
The high-yield bond universe did not fare as well, as inflation and rising interest rates pushed many investors to seek safer alternatives. After a very good first quarter, during which there was US$7.4 billion in high-yield bond buyback issues — up more than 80% year-on-year — the second quarter saw just $1.7 billion in additional issuance for these purposes.
Despite a tougher market, sizable buyout deals were completed in the first half of 2022. In February, 3G Capital priced a US$5.36 billion equivalent loan package to fund its acquisition of window covering manufacturer Hunter Douglas.
In the same month, government contractor Amentum secured a US$2.26 billion term loan facility to fund its purchase of another PAE contractor from Platinum Equity and the Gores Group.
The market is looking for direction
20% Loan issuance for buyouts reached $94.5 billion in the first half of 2022, up 20% year-on-year
Loan and bond issuance related to buyouts, however, were not immune to the market uncertainty created by events in Ukraine and rising inflation and interest rates. While the buyback issuance figures recorded in the first half of 2022 look good, they benefited from a pipeline of deals launched in 2021 that closed in the first three months of 2022.
However, as geopolitical and macroeconomic risks intensified, it became more difficult to push through buyout debt packages. Underwriting banks and institutional investors, as a whole, have taken a somewhat more cautious stance on funding high-leverage, lower-investment-grade buyout credits.
Investors in leveraged and high-yield loans, meanwhile, demand higher prices and wider initial issue discounts (OIDs) to gain comfort in a changing risk environment.
According to Debtwire Par, average OIDs and lending spreads have widened significantly since the start of the year, and this pricing pressure can be seen in several deals completed in the first half of the year. For example, Syniverse Technologies entered into a US$1.025 billion Term Loan B (TLB) to refinance debt in connection with Twilio’s acquisition of the company’s minority stake. The TLB, expected in 2027, has a price of SOFR +700 bps, up from the initial guidance of SOFR + 500–525 bps.
Lightstone Generation has completed the modification and extension of its US$1.463 billion TLB, pricing TLB at SOFR +575 bps, up 200 bps on existing loans, which were priced of LIBOR + 375 basis points in 2018.
Dry powder can support redemption appetite
According to Bain & Co., private equity dry powder is still at record highs, forcing buyout firms to keep rolling. This has supported buyout transaction volumes even as the broader M&A markets have cooled and could well lead to additional buyout issuances in the second half of 2022 if funding sources come to the table.
While the value of US M&A deals, excluding buyouts, fell more than 20% in the first half of 2022, year-over-year buyouts worth $235 billion were announced during of the same period, according to Mergermarket. well above pre-pandemic levels dates back to 2007.
Even though leveraged financial markets have cooled, investors are still seeking high-quality credits backed by familiar sponsors. Transactions can still be funded, but the quality bar is higher and funding is likely to be more expensive.
Direct lenders are gaining in importance
However, the most significant change in buyout financing since the start of the year has been the growing importance of direct lenders on increasingly large deals.
The roots of direct lending lie in smaller and mid-sized offerings and packages characterized by higher prices and tighter covenant packages. For jumbo deals, sponsors historically almost always defaulted in the cheaper and more liquid leveraged loan and high-yield bond markets, which also offered looser covenants.
Over the past two years, however, the direct lending option has become increasingly attractive to financial sponsors in a volatile market, and this trend has accelerated in 2022.
Unlike leveraged financial markets, where banks take out loans and then resell tranches to investors, direct lenders take out and hold credit. For sponsors, this removes syndication risk and delays, with direct lenders providing greater certainty of execution and terms.
The sponsors also noted that the price gap between the two products has narrowed. Direct lenders may charge a higher price upfront, but once OID and price flexibility in syndication are taken into account, the price difference is often minimal, with many sponsors finding that any premium direct loan is worth paying to eliminate the risk of syndication.
Direct lenders have also increased their assets under management over the past decade. With Preqin putting the private debt dry powder above US$1 trillion (up from US$400 billion in 2008), these lenders have more firepower at their disposal and are able to digest far more credit. important.
It has become increasingly common for financial sponsors to run dual-track processes by looking at both leveraged and bond loan options alongside what direct lenders can offer.
In some cases, buyout companies completely bypass the syndicated loan and high-yield bond markets. In 2021, Thoma Bravo funded 16 of its 19 buyouts with direct lenders, according to Reuters. It secured a $2.6 billion debt financing deal in March from a club of direct lenders, including Owl Rock Capital, Apollo Global Management, Golub Capital and Blackstone Credit, to fund its takeover of 10.7 billion from Bay Area software company Anaplan.
Direct lenders have also become more comfortable providing financing on softer and more flexible terms tailored to borrowers’ needs for larger transactions. Sponsors pursuing buy-and-build strategies, for example, can turn to direct lenders for deferred term loans that allow borrowers to draw cash over a long holding period to fund follow-on acquisitions.
Despite a volatile and uncertain market, financial sponsors are finding that they still have several options available when it comes to funding arrangements.