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European private equity firms look to deploy dry powder amid soaring valuations

Capital Markets View – February 2021

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LCD Monthly: Demand for US loans puts borrowers in the driver's seat

Capital Markets View – January 2021

2021 Leveraged Loan Survey: Defaults edge higher; credit quality a concern


European private equity firms look to deploy dry powder amid soaring valuations

With this effort LCD introduces a new European private equity monthly topical, which replaces the legacy PDF version of the report. The underlying chart data, as well as the data that was included in the PDF, is now available in a downloadable Excel format at lcdcomps.com.

European private equity sponsors, who head into 2021 with a large amount of dry powder to put to work on new buyouts, can rely on the support of extremely strong debt markets. But with valuations across Europe soaring to record levels, the pathway to making new acquisitions is not without its challenges. Indeed, total purchase price multiples reached a record high in 2020, having risen every year since 2015. Private equity firms will now therefore need to determine if higher multiples are simply the new normal, and will be mindful of the need to deploy their deep reserves.

At the end of 2020 the amount of dry powder that private equity firms had to put to work in Europe crept close to $300 billion, according to Preqin, which is more than double the amount available in 2012.

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This amount has ramped dramatically in 2020, with a higher level of aggregate fundraising reported than in any other recent year, according to Preqin.

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But despite this wealth of reserves to hand, private equity sponsors note that it has been difficult to utilize this cash recently in an effective way, as valuations in the market have risen to record levels.

Asset multiples are now sitting at some of the highest levels seen in recent years, thereby boosting potential buyout sizes. Indeed, the total average purchase price multiple in 2020 stood at 12.55x, according to LCD.

Balancing act
Finding a happy equilibrium between buyer and seller is rarely easy, and when talking to LCD News, some sources at private equity shops make clear that high valuations are a notable hurdle, but equally there does appear to be a thawing in the reticence to buy at high valuations. After all, the dry powder needs to be put to work in order for private equity firms to make the returns promised to their limited partners. "It is very aggressive now, especially around tech companies," said one sponsor source. "If you can buy inside 20x EV you are doing very well. We haven't spent 30x yet, but that day will come."

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Debt markets, though, are supportive in terms of both leverage and cost of financing. Indeed, leverage levels have crept up over the past year, with the average total debt-to-EBITDA multiple for European private equity sponsored deals now standing at 5.85x.

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On top of higher debt leverage levels though, average sponsor-contributed equity levels in 2020 rose above 50%.

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These rising technicals all reflect climbing valuations in the equity markets, where levels recovered from the March sell-off to show bullish strength. The S&P 500, for example, rose from a low 2237.4 on March 23 to end 2020 at a yearlong high of 3802.04.

Market participants note that the current situation also illustrates sponsors' increasing competitiveness when it comes to assets. While more portfolio firms may come up for sale in the coming year as private equity players look to exit investments they were left holding longer than anticipated over the volatile months of 2020, there is little expectation that this competitive pressure will ease.

"Auctions are difficult at the moment," said one private equity manager. "They're highly competitive, people can get very aggressive on price, and that can be very uncomfortable. Valuations have got to very stretched levels."

Indeed, competition for assets is not just coming from other sponsors in auctions. The effervescence of equity markets means that an initial public offering is an increasingly attractive exit strategy, and already in January Permira-backed British boot brand Dr. Martens Ltd. has announced its intention to float in London.

Meanwhile, market participants note that special purpose acquisition companies are likely to play a larger role in Europe over the coming years. Last year, for example, travel shopping tax refund firm Global Blue Group AG merged with Fair Point Acquisition, a SPAC set up by hedge fund Third Point.

While soaring valuations may make buyouts tricky for some, certain market participants are optimistic about the outlook for more sponsor-backed acquisitions of scale, given the sheer amount of dry powder private equity firms have at their fingertips. "I can think of nothing that will curtail activity this year — there's going to be a gush of deals," said one senior private equity banker.

"The financing markets are wide open, record levels of capital are available, and exits have been delayed. So it could get crazy. We will see some really large capital deployments happen over the next year. Big deals just have to happen."

Emergence of high-yield
Although volatility resulting from the COVID-19 pandemic shut markets in March and April last year, prompting some fears of a long-lasting closure, the volume of LBOs in Europe (including all sources of funding) rose year on year, according to LCD, to €49 billion from €45.5 billion in full-year 2019.

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But despite this uptick in the total volume of LBOs in 2020, LBO loan volumes fell as equity contributions were high, and sponsors increasingly turned to the fixed rate high-yield bond market.

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For example, while the financing backing the €16.14 billion buyout of Thyssenkrupp Elevator A/S by Advent International, Cinven, and RAG in summer 2020 included €3.58 billion-equivalent of term loans, the larger proportion of the financing (roughly €4.05 billion-equivalent) came from the euro- and dollar-denominated high-yield bond market. And elsewhere, MásMóvil Ibercom SA added a €720 million offering of secured bonds to the debt package backing its take-private by Cinven, KKR and Providence. The seven-year bonds priced at 4%, inside the 4.68% yield on the €2 billion seven-year term loan that also backed the acquisition.

One sponsor later admitted to LCD that, with hindsight, they may not have chosen to max out the loans on a particular transaction, for despite an aversion to high-yield due to cumbersome call protection in the latter stages of last year, it was a deeper market willing to offer lower yields.

In total across the year, the high-yield bond market supplied roughly 14.2% of leveraged financing backing European LBOs, compared with 8% in 2019.

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Still to come in 2021, more buyout financings are set to utilize both the public and private leveraged finance markets — not least the £3.5 billion of bonds and loans anticipated to support the takeover of U.K. supermarket chain ASDA by the Issa Brothers and TDR Capital — and sponsors note that bonds are now a key component of their arsenal.

"Bonds are now part of the discussion, whereas previously we'd have turned to the loan market almost by default," said one senior private equity manager. "The bond market has been so strong, and pricing — notwithstanding call-protection — has been incredibly compelling. The bond market came back more quickly than loans after the initial lockdown last year, but now, even with the loan market back and willing to step up for bigger deals, bonds are still interesting."

Ongoing support
Although buyout activity throughout 2020 proved to be stronger than some expected, sponsor-backed assets were clearly impacted by the pandemic. Throughout the year private equity firms supported their portfolio companies with equity injections to support refinancings and restructurings. Permira injected €600 million into credit management company Lowell Financial Services GmbH, for example, while Selecta obtained €125 million from owner KKR. This supportive streak has continued into 2021, with Bridgepoint providing Dutch catering firm Vermaat Groep B.V. with a €10 million equity contribution as the firm was downgraded.

"I think it's safe to say that in 2020 we saw fewer severe distressed situations than we expected, because of sponsor support for businesses," said one banker. "I've been really impressed by the resilience of private equity firms' portfolios, but more challenges will come up this year."

Although the number of distressed deals was muted by this sponsor support, there were 19 restructurings in 2020, according to LCD, which is the highest such figure in the last five years.

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The total sponsored volume of restructured debt in 2020 meanwhile was €5.13 billion, up on the €2.74 billion recorded in 2019.

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Overall, at the beginning of 2021 the creditworthiness of sponsor-backed assets is slightly weaker than it was at the beginning of 2020. Some 11% of sponsored loan debt outstanding in the European secondary market is now rated at CCC or below, potentially lining up more distressed challenges to come.

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But market participants note that both the number and volume of defaults and restructurings would have been dramatically higher, had private equity sponsors opted not to support their portfolio assets. "Sponsor behavior has been incredibly important," comments a fund manager. "By all traditional metrics, some companies ought to be deeply distressed, but aren't, as the market knows they have supportive sponsors, and subsequently can access the capital markets. Sponsors do not want to give up on assets they know will be good down the line."

Indeed, others note that while private equity players will continue to back their portfolio firms throughout 2021, the longer-term outlook presents more challenges as European governments end their supportive asset purchase programs. "Sponsor support will continue," said one private equity manager.

"The nature of this pandemic is that it's temporary, and most firms are fundamentally sound businesses facing a liquidity squeeze. But a post-pandemic recession will come one day as central bank support starts to end. At some stage, we will have to pay for all of this."