Private equity firms took advantage of unprecedented liquidity in the debt markets to take more cash out of their portfolio companies than ever before in 2006, according to a new report.
The report, by ratings agency Fitch, looked at 84 recycled leveraged buyouts – an umbrella term covering refinancings and sales to other buyout firms – over the course of last year. It found that during the year, sponsors took out more money from more recapitalisations than ever before in 2006. A total of 40 refinancing deals – over 50 percent more than last year – yielded €8.3 billion in cash from their portfolio companies, equivalent to 72 percent of the sponsors’ initial investments.
The driving force behind this was the huge amounts of money available in the leveraged credit markets. The report noted the “dramatic” increase in the number of leveraged credit funds, particularly CLOs (collateralised loan obligations). Other investors in the market have also been re-investing the high returns being generated, fuelling its momentum.
This extra liquidity has not only allowed sponsors to borrow more aggressively to fund deals, but also to dictate better terms when they refinance. The result has been more back-loaded debt structures – by reducing the debt burden in the early stages of ownership, sponsors have been able to utilise higher levels of debt during the acquisition process and thus pay more for deals.
This in turn has led to a steady rise in the value of portfolio assets. In 2006, the average recycled buyout had an enterprise value of 9.7 times the company’s earnings before income tax, depreciation and amortisation – higher than the average of 9.1 times ebitda for the leveraged loan market as whole. As asset values have risen, sponsors have been able to refinance at better terms and take cash out to distribute to investors or pay down debt.
The most popular sectors for this kind of “recycling” were building and materials, industrials and manufacturing, and automobiles. All three are traditionally considered to be cyclical industries, suggesting that sponsors may have been making hay while the sun shines, taking cash dividends while economic conditions are favourable.
Food and beverage was another sector where recycled buyouts were popular. One firm in this sector, Weetabix, the cereal brand bought by Lion Capital, was even refinanced twice during the year – in February and September.
Fitch believes there is no imminent sign of the unprecedented liquidity in the credit market drying up altogether, even if leverage multiples are likely to stabilise. Default rates may be on the increase, but only compared to their recent historical lows. However, the report argues, the increasingly fierce competition for assets, coupled with the growing importance of refinancings for buy-and-build strategies, will ensure that there is no let-up in the pace of recycled buyouts in 2007.