The leveraged finance market is in a state of flux, and nowhere is this more clearly illustrated than in the case of two very contrasting buyouts, that of industrial chemicals company Evonik, which has struggled in syndication due to concerns around cyclicality; and separately, life sciences company LGC Group, which has enjoyed a warmer welcome in the market, with total leverage including PIK in excess of 7.5x, and with a number of funds providing the PIK tranche.
On the one hand, you have companies with healthy growing cash flows and little to no cyclical influences. These businesses will continue to enjoy ravenous appetite from the both banks and debt funds active in the leveraged finance markets, as competition drives high leverage and also from buyers who are focusing on securing the very best businesses equipped to handle a suspected downturn.
On the other hand, you have companies that are more exposed to the economic cycle. Going into 2020, they will find it even more difficult to raise debt or refinance, with varying levels of appetite depending on the end markets, the extent of cyclicality within their business models, and the perceived extent of protection in a downturn. These credits will need to be shown to a wide lending audience given the binary responses that are often seen from bank and direct lenders alike. In a majority of cases financing will be available for them but at distinctly modest leverage levels.
Established technology companies typically fall into the first camp, as well as healthcare businesses that can demonstrate high non-cyclical growth and strong cash flow generation. As a sector, healthcare benefits from long-term growth drivers including ageing populations, whilst the disruptive nature of many technology business models will drive strong revenue growth, market share gains and enhanced cash flow.
The second camp increasingly comprises consumer & retail, as well as industrial companies. These cyclical businesses face a slowing global economy and have typically been affected by the trade war between China and the US. But they also face structural pressures. In retail, the demise of high street brands that have failed to fully embrace ecommerce is plainly evident with high profile failures and where possible restructuring involving landlords having to reduce rents. In a similar vein, many manufacturers particularly in the auto supply chain are facing structural pressures as new battery technologies and tougher emissions standards upend the entire industry.
To be sure, there will always be exceptions to the rule in these sectors: some retail and auto businesses will continue to command high valuations and leverage due to specific attributes such as, in retail, a well-developed ecommerce and rental-lite model or in the case of automotive, selling into the electrical segment of the industry.
So what does all this mean for investors? Many GPs have been raising billions of dollars and euros for distressed funds that spot opportunities in these restructurings.
For banks and direct lenders that provided leveraged finance at the top of the economic cycle, it is likely that their portfolios will deteriorate in the current economic backdrop, with at best portfolio companies missing forecasts but with the risk of flat or even reducing EBITDA.
In the cov-lite part of the market, which for the year to end November accounted for over 90 percent of the European syndicated leveraged loan volume, there will be limited opportunity for lenders to react. Within the mid-market, where typical loan agreements may include a net debt to EBITDA maintenance covenant, we could see increased pressure on covenants and lenders engaging with borrowers and owners to resolve the under-performance.
Paul Bail is head of European debt advisory at Baird