Credit crunch healthy for buyouts(2)

The large buyout market has experienced a healthy correction and there will be a rebound in large public to private transactions as soon as the end of 2008, according to a report by Swiss alternative assets manager Partners Group.

Partners said large-scale public to private buyouts will resurge in late 2008/9 as credit markets and seller expectations readjust.

“Public companies continue to be reasonably priced with healthy balance sheets, and an unbroken demand for the asset class – especially from institutional investors and from sovereign wealth funds – should increase the shooting power of private equity companies,” it said.

Partners’ bullish stance is despite a 62 percent drop off in worldwide buyout volume in the second half of last year to $220.9 billion (€151 million), down from $575.2 billion in the previous half, according to data provider Dealogic.

“It is the leveraged loan market that will in the end pay the price for overheating”, Partners said. Default rates would rise and anxious debt investors “now realize they have underwritten assets too cheaply with little to no handle to improve their situation [due to the prevalence of covenant lite loans]”.

But Partners said, for buyouts, the change was a healthy correction as it had led to entry multiples retreating and leverage levels falling. Some buyout investments would suffer from an unsustainable debt burden, but others would benefit from high leverage at low costs, Partners said. This would lead to average vintage years for 2006 to 2007 funds.

Partners also said the last six months had confirmed its positive view of venture and growth opportunities. The investment pace in venture and growth in the third quarter of 2007 was the highest quarterly total since the first quarter of 2001, it said. The exit market had also improved for venture and it expected this to continue in 2008, Partners said.

This week, venture firms Index Ventures, Balderton Capital and Benchmark Capital sold MySQL, an open source database business, to IT firm Sun Microsystems for $1 billion.

Mezzanine’s comeback in the last six months was also likely to continue, it said. The form of hybrid debt had been supplanted by cheaper senior and second lien tranches during the buyout boom.

The firm remained cautiously optimistic about CLOS, arguing the reaction against the debt instruments in the wake of the global credit crunch had been overdone. “If leveraged up, the equity return to a CLO can still be substantial [as average asset spreads had increased] – but only if the issuer has access to mezzanine tranches.”