There's bad news for lenders and others who have been scouting for signs of a pickup in general M&A that could boost — or at least sustain — issuance of leveraged loans.
High price tags on some recent corporate deals have prompted buyers to hold off.
Issuance of loans to fund M&A remains subdued as a result, especially when compared with the peak of $471 billion in 2007, according to a July 29 report from Thomson Reuters LPC. M&A activity in the first half of 2013 reached $135 billion. It is on pace to match the full-year total of $262 billion in 2012.
Though the leveraged buyout portion was higher than a year earlier, a single megadeal skewed it: Berkshire Hathaway's $13 billion purchase of H.J. Heinz Co. that it made with an investment fund affiliated with 3G Capital. This transaction made up more than 33% of the LBO volume in the first half.
Loan investors were happy to see two more of these big transactions hit the market in the third quarter: the industrial-equipment manufacturer Gardner Denver's $3.9 billion acquisition by KKR & Co. and BMC Software's $6.9 billion purchase by a private-investor group led by Bain Capital and Golden Gate Capital. Combined, the funding for these two transactions provided $8 billion in new paper to "starved" leveraged-loan investors, LPC says.
Meanwhile, M&A among investment-grade companies is also tracking 2012's rather lackluster numbers given that volume only totaled $51 billion in the first half of the year. This activity was dominated by two large financings.
Ioana Barza, a director of analytics at Thomson Reuters LPC, says that if the megadeals continue, it would absolutely help to lift leveraged-loan volume.
But issuance is already at historical highs right now, mostly driven by refinancing activity, so it would take a significant amount of M&A to manifest as a big jump from already high levels. Conversely, "we may see a decline in refinancing activity as arrangers and investors focus on new-money M&A deals, should the pipeline pick up," Barza says.
And despite the fact that many companies have recently executed these jumbo transactions, it might not be an easy trend to keep up, except for specific situations, given that these deals are hard to execute.
"Larger deals require larger premiums to be paid," says Richard Farley (pictured), a partner at Paul Hastings. The law firm served as advisor to the banks participating in the Gardner Denver financing.
They turn off private-equity investors, who prefer diverse holdings; and sometimes they present logistical challenges.
"Very large M&A transactions are hard to do, hard to find private equity for ... and are hard to syndicate, although money is certainly available," says Barry Brooks, a partner in the corporate department at Paul Hastings. "In reality, also, it's hard to find big-target companies, which represent good buyout opportunities for a variety of reasons."
So what is driving the large transactions?
According to Barza, arrangers are saying that there is no better time to borrow. There is also a considerable amount of money sitting on the sidelines.
However, the outlook for M&A seems to be mixed. In recent weeks M&A talk at the board level has picked up for the first time in a long time, she says. But, translating that chatter into live deal is another matter altogether, Barza says.
It is more difficult for CEOs and sponsors to pull the trigger given that investors are still timid about taking risks and pursuing transformative deals.
"Volatility is here to stay," Barza says. "That's a mind-set change that might take some time for CEOs to work through. Clients need additional time to adjust and learn how to live in this current environment."
She added that the gap between the expectations of buyers and sellers is still an issue. Valuations have risen, and sellers are willing to wait or pursue a dividend recapitalization in the meantime, which some almost view as a "quasi-annuity."
"Buyers might not be as worried about Europe or the economy as much as they may be struggling with paying for a company that was worth half as much a year ago," Barza says.
"Conditions have been fertile for a robust market for quite some time now," Farley says. "Debt markets are attractive, there has been reasonably predictable economic growth, so strategic requirement for consolidations and leveraged buyouts are present and the private-equity funds have significant dry powder for cash investment. The thing that's putting a damper for what should have been a robust two years is that there's a bit of a disconnect in the bid-ask; the expectations of sellers are out of alignment with what buyers are comfortable paying ."
Barza added that sponsors are looking three to five years down the road, asking themselves: If I buy it today, what can I sell it for? What will the exit strategy be in four to five years? The cost of debt will be higher by then and the ability to sell at a higher multiple may be harder given today's levels.
Whether a private-equity firm will be able to exit an investment in three to five years would depend on the type of business, according to Farley.
He says that no one really knows if a company will turn out to be an ideal candidate for an initial public offering or whether the terms of the equity capital markets will be robust at any time in the future relative to historical activity.
"One has to size growth prospects and to determine whether the company can exit through an IPO, a sale to a strategic buyer, or a sale to a sponsor or through a dividend recapitalization as we have seen frequently recently," Farley says. "I don't think the availability of the exit drives day-to-day decision of companies to make acquisitions."