A tide of M&A activity has been sweeping through private debt firms over the past year, driven by a combination of quests for bigger profits, disgruntled shareholders and the threat of risk retention compliance. That tide shows little sign of ebbing in 2016 with experts predicting more M&A activity.
While most private debt firms don't deny the need for scale, they need to be careful in their pursuit of growth at a time when credit and equity markets are increasingly volatile and debt managers are seeing a significant uptick in defaults and bankruptcies.
BDCs ON THE BLOCK
The BDC market suffered a tumultuous 2016 amid criticism of underperforming managers and negative press coverage. The result is that some BDCs are now for sale – some officially, others less so.
American Capital (ACAS), after suffering shareholder criticism from hedge fund Elliott Management, said it would embark on a strategic review of its business and hired Credit Suisse and Goldman Sachs to advise on a potential sale of its $8 billion portfolio.
Industry sources tell PDI that Ares Capital Corporation (ARCC) would be the most likely buyer and the BDC filed proxy materials with the Securities and Exchange Commission (SEC) in February seeking permission from shareholders to issue equity below book value. The BDC has been trading at about 0.9x its net asset value (NAV) lately and would need shareholder approval to raise stock.
Although Ares has sought to renew this permission annually for the past seven years, the proxy materials and ARCC's subsequent earnings call noted that the environment looked particularly attractive for acquisitions. “We think about acquisitions being more interesting today, because things are a lot cheaper than they used to be,” said ARCC chief executive Kipp DeVeer in February.
Fifth Street Asset Management, which has seen two of its BDCs become the subject of shareholder criticism and lawsuits in recent months, is said to have engaged M&A firm Greenhill & Co. to explore selling parts of its business. Both firms have declined to comment.
Meanwhile, the back and forth saga around TICC Capital Corp, is continuing. Its planned sale to Benefit Street Partners failed to gather enough shareholder support in December amid claims that the offer was “rigged” and paid undue money to management.
TICC has not engaged with two competing offers and its management says they are keeping the current investment advisor in place, even though it's been underperforming for years.
THE GE CAPITAL SELL-OFF
M&A activity in the BDC space is not the only game around. One of the biggest stories to rock the lending world last year was General Electric's announcement that it would be selling off most of its GE Capital lending units. By January, GE had sold over $157 billion worth of lending assets. GE intended to bolster its balance sheet and avoid the Systematically Important Financial Institution label that the US Treasury has been slapping on firms deemed too big to fail.
GE Antares, which focuses on mid-market sponsor-backed transactions and probably the best-known arm of GE Capital in the private debt world, was sold to the Canada Pension Plan Investment Board (CPPIB) in August for $12 billion. Antares remains a separate business from CPPIB's own lending platform, the Principal Credit Investments group, and most of Antares' senior executives were kept in place. They are now said to be back out aggressively doing deals to catch up on the momentum lost while in transition.
Antares' competitors often refer to the business as the “crown jewel” of sponsor-backed finance and are glad that it didn't disappear from the market. However, sources say that the interest rates Antares charges borrowers, which used to be very low, are likely to rise under the new owners.
Also said to be on the market is Chicago-headquartered NXT, launched in 2009 with money from Stone Point Capital, a Connecticut private equity firm. That capital came from a fund nearing the end of its investment period and which will need to start returning gains to LPs. As such, the NXT stake looks set to be sold.
NXT was rumoured to have come close to a deal with Apollo last year, though sources say the price was too high. NXT denied this.
Robert Radway, NXT's founder and chief executive, has built two other lending businesses, both of which were sold to GE Capital. With that business now out of the market, a natural buyer is no longer around.
CLOs AND OTHER DEALS
In the CLO market CIFC is looking for a new stakeholder. The asset manager, which has been looking to expand into Europe and build risk retention-compliant deals, has engaged JPMorgan to help it find a new equity infusion.
CIFC is publicly traded and majority owned by family office Columbus Nova, which would likely see its stake reduced once a new shareholder arrives. Oliver Wriedt, CIFC's co-president, has stressed that this would be a management-led deal that would see its current executives stay in place.
CLO managers, particularly smaller ones, have been under pressure to sell as the US risk retention deadline approaches and issuance has been down.
New York-based Conning acquired Octagon Credit Investors' CLO business in February. Matthew Nicholls, managing director at FIG North America at Citi, worked with Octagon on the transaction, while Christopher Spofford, partner from Broadhaven Capital Partners, represented Conning.
Ted Gooden, managing director at Berkshire Capital, worked with Regiment Capital Advisors on the sell-off of its remaining CLOs to Bain Capital Credit in November. Regiment, which also shut down its credit hedge fund from mounting losses tied to falling oil prices, appears to have now closed. When the hedge fund was winding down in May 2015, CLOs were the only product left. Regiment also sold its direct lending unit and team to TCW in 2013.
Many other firms have been struggling with their energy portfolios.
Ares Management, which was planning a combined alternative investment firm with Kayne Anderson Capital Advisors, called off the merger in October citing energy concerns. At the beginning of last year many firms were planning to invest more in energy, betting on a recovery in oil prices. But as prices kept falling the signal to Ares was that purchasing a firm with a large energy business was no longer viable.
“There is no question Kayne is an industry leader in energy, energy infrastructure, real estate and other asset classes,” Tony Ressler, Ares' chairman and chief executive, said announcing the split.
“While we continue to strongly believe in Kayne and the long-term energy investment opportunity, it became clear this was not the right time to bring together our cultures and business models into a merged public company.”
However, it was announced that Ares and its principals would invest $150 million in Kayne Anderson funds.
Sources also point out that housing a large energy book within a publicly traded asset management firm like Ares would have been challenging, as the firm would have to mark its investments to market and report losses on a quarterly basis. That issue has been seen already, with Blackstone reporting declining financials in its Q4 report. The firm's GSO credit group has as much as $11 billion of its $79 billion invested in energy.
Apollo, which shares ties with Ares, has been trying to bulk up its platform as well. The firm is said to be looking to expand in mid-market lending, so a look at NXT would have made sense. Apollo had bid on Antares and several other GE Capital divisions. It was also plotting an acquisition of Nick Schorsch's real estate empire, AR Capital, before the deal was called off in November.
WHAT LIES AHEAD?
The American Capital sale, whether to Ares Capital or another suitor, is likely to get done soon as the firm has spun off assets and made share repurchases to bolster its financials and price-to-NAV value.
Other recent deals involved Highbridge Principal Strategies, which is said to have completed its planned management buyout from JPMorgan in March. The hedge fund, Highland Capital, stayed with the bank while the credit group spun out.
Sources tell PDI that JPMorgan wrote a loan backing the new business, which has about $28 billion under management
Meanwhile, fledgling BDCs are likely to sell or be swooped upon by firms looking to get into the BDC space (of which there are many), while smaller CLO shops will likely continue to sell to bigger firms.
Both Ares and Apollo will hunt for more acquisitions to continue to grow their businesses, though both these firms and others have learned lessons from the failed deals of yesteryear.
Sources also tell PDI that several prominent private equity firms are looking to build private debt divisions, while banks continue to cut leveraged lending staff. They expect these trends to be a continued source of M&A activity. Industry experts also expect some tension in acquisition negotiations this year, with buyers and sellers battling over purchase prices.
MYSTERY MAN WITH HIS FINGER ON THE PULSE
He refuses to do interviews and JPMorgan won't share biographical details or issue a photograph of him, but one figure lies behind many of these deals.
Mark Feldman, vice-chairman of investment banking within JPMorgan Chase's Financial Institutions Group (FIG), was involved in most of the GE Capital sell-offs, including Antares.
Feldman, who has been at JPMorgan for most of his career, ran its Finance & Asset Management business for many years.
The University of Pennsylvania Wharton School graduate is credited with establishing several activities within FIG, including the alternative asset management banking business. Feldman advised GE on its IPO and spin-off of Synchrony Financial. He also led the IPOs of The Carlyle Group, Ares and Apollo Global Management.
Feldman's name crops up in many other M&A deals and conversations with private debt executives. He advised Kayne Anderson on its plans to merge with Ares and has been shopping NXT Capital around to potential buyers. At the moment, he is also working with CIFC on finding a new stakeholder for the CLO specialist.