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European leveraged finance: COVID-19 and the flight to quality
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Buyout rebound reflects optimistic outlook

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HEADLINES

  • Private equity deal value in Europe totalled €26.5 billion in Q2 2020, the lowest quarterly figure since Q3 2013
  • High yield bond issuance for leveraged buyouts (LBOs) in Europe is up 39% year-on-year to €7.8 billion
  • European leveraged loan LBO issuance declined by 6% to €36.8 billion year-on-year

The first half of 2020 was challenging for finance issuance around LBOs in Europe, but a rebound in activity late in the year offers encouragement for lenders and borrowers in 2021.

Private equity deal value in Europe reached its nadir in Q2 2020, totalling €26.5 billion—the lowest quarterly figure since Q3 2013, according to Mergermarket. Private equity deal volumes for the year, meanwhile, declined by around 10% year-on-year.

This hiatus in private equity deal activity following COVID-19 lockdowns weighed heavily on LBO debt issuance. Even though high yield bond issuance for LBOs has been strong—up 39% year-on-year to €7.8 billion—the much larger European leveraged loan market saw LBO issuance decline by 6% to €36.8 billion over the same period, according to Debtwire Par. Financial sponsor deal activity, however, bounced back at the end of the year, pointing to improved deal flow going into 2021.

 

Lender demand remains resilient

For all the uncertainty imposed by COVID-19, the combination of low interest rates and extensive quantitative easing means that lenders remain eager to deploy capital. This was true throughout 2020—when there was limited deal flow and LBO deals came to market, appetite was robust.

Banks underwriting the debt for the €17.2 billion carve-out of ThyssenKrupp's elevator division by Advent and Cinven, for example, were able to sell €8 billion of loans and bonds to finance the deal, despite pandemic uncertainty. The banks behind TDR Capital-backed pub chain Stonegate, meanwhile, sold down £1.2 billion of bonds in July to finance Stonegate's takeover of the UK's largest pubs operator, Ei Group.

With recent LBO deals—including Permira's buyout of pharmaceuticals group Neuraxpharm and Ardian's purchase of Angus Chemical—also tapping into leveraged finance markets successfully, indications are that lenders will continue displaying strong interest when deals come to market.

The signs for overall M&A deal activity going into 2021 are positive, with a clearer view of future earnings and pricing, which should give lenders more transactions to finance

 

 

Outlook promising for M&A

The signs for overall M&A deal activity going into 2021 are positive, with a clearer view of future earnings and pricing, which should give lenders more transactions to finance.

Opportunities to acquire assets at more reasonable valuations have also opened up, according to the Argos Index, which tracks the multiples paid for private European companies valued in the €15 million to €500 million range. In the first half of 2020, multiples paid by investment funds dropped to 9.2x EBITDA on average, according to the Index.

Pricing recovered later in the year but, by Q3 2020, deals trading at multiples of 20x EBITDA had all but disappeared from the market.5

Dealmakers are also replete with capital. Bain & Co figures put the amount of dry powder available to private equity firms, globally, at US$2.5 trillion, of which US$800 billion is targeting buyouts.

On top of this equity war chest, financial sponsors have also benefitted from cash-rich private debt lenders who are eager to lend.

For example, in July 2020, Ares Management arranged the largest ever unitranche loan when it made a £1.875 billion financing commitment to UK insurance brokerage Ardonagh Group. Preqin data, meanwhile, shows private debt assets under management sitting at a record US$823 billion, of which US$279.4 billion still needs to be deployed.6

Add in pent-up demand from CLO and high yield investors, and it looks as though fierce competition among lenders will support strong M&A leverage going into 2021.

 

Sponsors show support

Transaction activity will also be bolstered by a broader pool of dealmakers and investment strategies: Financial sponsors are clubbing together with other funds and investors to open up new sources of deal activity.

Cinven and Advent, for example, joined the RAG Foundation to pursue the ThyssenKrupp deal, while Bain Capital partnered with Finland’s Ahlstrom and Ehrnrooth families to take private Finland-based fibre solutions provider Ahlstrom-Munksjö in a €2.1 billion transaction, according to Unquote data.

Further public-to-private deals are expected to remain a feature of dealmaking, with appetite for take-privates holding up well into the second half of 2020, as observed with KKR, Providence and Cinven securing the US$3 billion delisting of Spanish telecoms group MasMovil in the early autumn.

Activist investors may also continue to spur deal activity—in 2020, Activistmonitor recorded 52 new live activist campaigns in Europe (meaning that the activist had both disclosed a stake and made at least one demand), up from the 50 campaigns recorded in 2019.

The influence of Special Purpose Acquisition Companies (SPACs) in the US on European deal activity should also not be underestimated. Around 248 US SPACs—shell companies that list and then seek acquisition targets—have come to market in 2020, raising US$82 billion, according to Dealogic. These vehicles have two years to invest the capital. Managers are incentivised to transact with a 'promote' that grants the SPAC sponsor a 20% share of the vehicle's equity.

Even though the domestic SPAC market in Europe has been subdued when compared to the activity in the US, SPACs are likely to come shopping in Europe for deals to deploy their large cash piles.

With such a broad range of investors scoping out transactions, valuations should widen, which will help to see more deals over the line.

European deal activity is poised to take off in 2021, but financial sponsor-buyers and lenders may remain highly selective—they will likely coalesce around highquality assets and distressed companies, where investors can buy in to sectors directly impacted by lockdowns at low valuations

 

 

Selective investors

European deal activity is poised to take off in 2021, but financial sponsor-buyers and lenders may remain highly selective—they will likely coalesce around high-quality assets and distressed companies, where investors can buy into sectors directly impacted by lockdowns at low valuations.

Lenders appear to be positioning themselves along these lines. According to Preqin, for example, special situations fundraising this year climbed just under sevenfold from March to April, while distressed debt fundraising in May and June was close to quadruple the levels seen in March and April.7

 

5 "Decline in share of transactions at multiples > 20x EBITDA". The Argos Index mid-market, 3rd quarter 2020.
6 "Where does debt sit on the LP radar?". Webinar presentation. Dave Lowery. July 2020. Prequin. Real Deals.
7 "Where does debt sit on the LP radar?". Op cit.

 

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European leveraged finance: COVID-19 and the flight to quality

 

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