While M&A has remained sluggish over the last year, some deals have gotten done. What’s notable about these closed deals is the high percentage that have relied on private credit as their lending source. Through continued rising interest rates and a banking system teetering on crisis mode, the syndicated loan spigot has been virtually shut off. And through all of this, private credit has barely skipped a beat. Just how big will this market get?
While 2022 private debt fundraising fell short of 2021’s record pace by about 20 percent, the total still exceeded the $200 billion mark for the third year in a row, according to data provided by Pitchbook.
PE dealmakers increasingly are relying instead on private debt funds as their primary choice of funding a deal.
In 2023, buyout activity overall has continued to crawl along; but of the financings that are being carried out, the lion’s share involve private lenders. Of the 28 take-privates announced since early June 2022 in the U.S. and Europe, totaling more than $54 billion in aggregate value, not a single deal had been funded by banks, according to Pitchbook.
Deals are Getting Done
It’s true that with leverage more expensive and the economy so fragile, there has been a slowdown in deals across the broader industry. However, quality businesses in non-cyclical sectors with strong cash flows are nevertheless being financed by private credit managers. Deals are getting done. That’s according to Jessica Nels, head of capital markets at Churchill Asset Management, a big player in the space.
With 200-plus private equity partners and $46 billion in committed capital, Churchill provides financing to PE-backed companies predominantly in the middle market. Even in a lull, Nels says Churchill remained relevant, flouting dire forecasts. “When the broadly syndicated market essentially closed in the second half of last year, it allowed scaled private credit players like ourselves to showcase our nimbleness,” Nels explains.
Going forward, if and when the rate environment even semi-normalizes, possibly later in the year, she says, “we expect M&A to build substantially and potentially return to those previous levels.”
What has market participants salivating in the wake of the financial system’s version of March Madness – Silvergate, Silicon Valley Bank and Signature, closing in rapid succession – is the looming prospect of large, medium and small banks all retreating to the sidelines. Meanwhile, in private markets, the amount of untapped dry powder remains abundant.
But remember, points out Paul Marino, partner at the securities law firm of Sadis & Goldberg, “all that dry powder is controlled by entities that are beholden to definitive terms – and need to get money out the door.”
In other words, he says, throwing up a basketball analogy, “the shot clock is ticking.”
Inventory will be pilling up. Eventually things will go on sale.
Even in the midst of a high-interest-rate-hampered buyout market, Churchill kicked off 2023 by raising $737 million worth of commitments for its Junior Capital Opportunities Fund II, exceeding its $500 million target.
“Going forward, private equity is going to play a heavy hand in being lenders of choice in a lot of transactions,” predicts EY’s Chris Le Roy, a partner in charge of the firm’s strategy & transactions group.
“There’s a real dislocation in the lending market,” Le Roy says. “The syndicated market is just not there. And moreover, the syndicated market doesn’t have the appetite for the risk right now because they’re trying to figure out where interest rates are going to settle. Even when they do, my sense is that there’s a general lack of understanding of how companies are going to operate in this higher interest rate environment.”
“In 2021 and the first part of 2022,” Nels adds, “the private credit industry was as busy as it has ever been.”
The end of last year and the first quarter of 2023 were relatively slower. Many of the deals that did get done involved carve-outs snatched up by PE funds looking to augment existing portfolio company platforms.
Le Roy explains how private lenders have been tapped for deals that would have historically gone to the leveraged loan market, based on its ability to offer flexible terms, speed and certainty of close. “One of the lasting legacies of this market will almost certainly be the elevation of private debt as a funding mechanism for PE transactions,” he says.
“The credit market is multiples larger than the private equity market, so if the state of private capital is to drive outsized returns, private equity, holistically, is going to have to move,” Le Roy says, leaning on Wayne Gretzky’s ice hockey adage about skating not to where the puck is, but instead to where it is going to be.
For PE, that puck, Le Roy says, is moving towards a diversified portfolio of vehicles to attract investment. For traditional middle-market equity investors, this means they will have another source of capital that they can count on.
“Private credit has historically been more expensive than syndicated financing, but we’re entering a period where there’s going to be a reset, and the spread could narrow between them,” Le Roy says.
Building War Chests
Direct lending funds in particular represent the most prevalent strategy within the debt fund category, with direct lending accounting for more than one-third of funds raised, and more than one-third of total assets under management. At $146 billion, the direct lending bucket is home to the greatest silo of dry powder, looking across all debt strategies, according to Pitchbook.
Some noteworthy examples of healthcare companies snapped up this past March in private deals include SAI MedPartners’ acquisition of PharmaForce by Northlane and PSG-backed DoseSpot buying TreatRx from Bravado Health.
“In a time of declining deal volume, private credit has really stepped up,” Le Roy says.
