Last year was not a bad year for private equity buyouts financed by private debt.

It is well to remember that US-targeted leveraged buyout deal value has experienced a steady increase through the period since the global financial crisis. In 2022, though down somewhat from the record-shattering year of 2021, it still totalled more than $200 billion, making 2022 the second-busiest post-GFC year in the space.

Kate Marino, in a piece for Axios in January, noted that the deal value of 2022 was “61 percent higher than the pre-pandemic average (2013-19)”.

However, the corporate debt and bank loan markets seized up in the middle of 2022. Central bankers turned off the spigot of liquidity worldwide. M&A activity fell to $3.6 trillion in 2022. This is 9.3 percent lower than the pre-pandemic five-year average (2015-19). In North America, M&A activity was 15 percent below that average. This created a vacuum, and private debt moved in.

The headline-grabbing take-private deal of 2022 was Elon Musk’s takeover of Twitter. In many ways the deal was an outlier. In financing, though, it seems typical and old-fashioned. In April, Musk put together a bank-led syndicate that included Morgan Stanley, Bank of America and Barclays. He also sold much of his Tesla stock ($8.5 billion) to pay cash for much of the equity.

The Thoma Bravo deal for Coupa Software is more typical of the latter half of the year, and perhaps prototypical of a new normal for private debt and private equity.

In December, Thoma Bravo entered into an agreement with the California-based cloud-based business software provider to take it private.

Valuation in a dislocated economy

Different approaches produce ‘very different results’, says Oaktree’s head of North American sourcing and origination

An executive responsible for sourcing and origination in one of the private lenders that allowed Thoma Bravo to finance its Coupa deal, Oaktree, spoke to Private Debt Investor about the funding of M&A activity as a private debt strategy (though not about the Coupa deal specifically).

Milwood Hobbs Jr, Oaktree Capital Management’s head of North American sourcing and origination, describes the existing market as “dislocated”, in terms of the valuation of potential target companies. “In valuing a private company,” he says, “there are at least two approaches. One can look at its earnings, the EBITDA side, or one can look at comparables – the value of public companies in analogous positions. We have entered a time of dislocation, when these approaches produce very different results.”

Another way to look at this: EBITDA doesn’t yield a valuation without a multiple. Where does the proper multiple come from? There is nothing magical about this question, but nothing mechanical about its answer. The multiple is generally a historically grounded rule of thumb, developed industry by industry. But we are living through dislocated times: a term that may be defined more precisely as times of stress (from, for example, inflation fears, supply-chain tangles and the real possibility of default on US Treasuries, which have long been regarded as the world’s least risky bonds). The sensible historic rules of thumb may no longer apply.

‘We price risk’

This dislocation has created opportunity. Asked whether 2023 will be busier for Oaktree than last year was, Hobbs says it will, “not because there are more deals to be done but because we will approach them with fewer competitors. We will be busy in much the same way that we were busy for a 40-day period in 2020”.

It is in this context that at least some private equity funds will be so eager for deals they deem propitious, based on their own valuation, that they will take the risk of buy now, finance later. It is in this context that some private debt funds will have to decide whether to join them, helping with that financing.

One key, in a moment of dislocation, is to keep one’s eye on the basics. Or, in Hobbs’ words, in such a market “everybody thinks that we can find the bottom and buy value there. In fact, though, that is always uncertain. At Oaktree we price risk”.

Coupa has been a listed company since 2016. The agreement valued it at $8 billion, or $81 a share. Coupa’s stock has since been trading at a slight discount to that contract valuation, at just below $80. Assuming regulatory approval, the deal is expected to close in the first half of this year. This agreement, created at a time of pessimism about the tech industry and uncertainty about the broader macro environment, required that Thoma Bravo borrow money from a group of direct lenders, led by Sixth Street. HPS Investment Partners and Oaktree Capital were each among the participating lenders.

Two final points on the Coupa deal

The Coupa deal is of a piece with Thoma Bravo’s track record. It buys mature enterprise software companies and takes them public. This was its playbook with Prophet21 (2002), Riverbed (2014), Instructure (2020), and – early in 2022 – with Anaplan. As of the end of the third quarter of 2022, Thoma Bravo had $120 billion AUM.

One somewhat unusual aspect of the Coupa deal is that shareholder pressure on the target company’s side was against the sale. More often the dissident shareholders believe that management is too reluctant to sell, and charge it with clinging to its own independence against their interests. In this case, though, many shareholders took the view that management was selling too quickly and at too low a price, and that it ought to have held out for a higher bid. Nonetheless, the Coupa closing is expected within the first half of 2023.

How the value numbers rolled along

There were 26 take-privates announced in the US and Europe between June and December 2022. Not one of them was funded by banks. Every one of them relied either on all-equity structures or on private debt funds.

In early 2023, private debt funds will likely continue to dominate the scene. As Marino observed, the deal value numbers rolled along after the mid-year seize-up because the private debt market stepped in to make it possible.

KKR’s acquisition of April Group, the insurance broker, is worth mention here. KKR bought April Group from CVC with an all-equity deal. But, according to Reuters, citing a source with knowledge of the deal, it did so with the intention of “raising debt funding down the road”.

As the KKR deal demonstrates, there is a mostly unspoken atmosphere of “buy now, finance later” at work. PE firms make a leap of faith, commit themselves to a deal, make the down payment, and then look for the funding. PD funds, then, can come to their aid like a (mercenary) knight on a white horse.