25.1.11

Two Very Interesting Charts, re Q4-10 Buyout Activity

In leveraged finance, stripping away all romance, there are two primary deal drivers: 1) valuations that matter to sellers; and 2) debt capital that allows buyers to afford these prices.

Aside from first-tier strategic buyers, financial sponsors (private equity/LBO funds) are the key players in the middle market. As regulation, technology and trading economics have driven the market value threshold for public companies to $500MM+, investors like foundations and endowments have decided to skip the public markets, and invest in sub-$500MM companies through private funds.

During the M&A market peak of 2006-2007, PE/LBO investors were approximately 1/3 of all announced deal volume in the $100-500MM size range. In Q4 2010, transaction activity surged and equaled those peak years.

The first chart below, tracks private equity portfolio exits since 2006. Exits matter because they generate real returns for investors and re-investment in new funds. Exit activity in Q4 signals an improvement in valuation, but more visibly – looking at the green bar, it shows an increase in secondary buyouts – sales from one private investor to another. These sales are usually fully valued and very dependent on the availability of bank debt.



Chart Source: Pitchbook

This point is important for private company owners: The debt markets for lower middle market deals are opening up again.

Our view of the economic cycle, bank balance sheets and lending spreads/fees, sees this accelerating in 2011. In addition to the increasing availability of funds, low interest rates are helping make transactions more appealing to buyers.

The second chart below shows lending to financial sponsors by type of deal.

Chart Source: Thomson Reuters LPC

Dividend recaps are simply new lending facilities for existing investments, allowing PE/LBO investors to take chips off the table. The more meaningful Q4-10 data, in our opinion, are the two blue bars “LBO and other deals.” These are again close to peak year statistics, and show that the banks are willing to lend into new deals as well.

During 2011, the banks will see a string of positive announcements, as problem assets shrink, and regulators approve dividend payments to shareholders. This in turn will generate pressure to grow, and put money to work in new loans. These changes within the banks are going to greatly improve the abilities of middle market companies and investors to get deals done.