Strategy Bain Capital negotiates the higher hurdles

Bain Capital explains how it is navigating the difficult economic waters ahead.

In the past few years, “We’ve probably had four or five different markets… which is not exactly typical”, says Michael Ewald, managing director and global head of the private credit group at Bain Capital, with admirable understatement.

He references pre-covid, covid itself, the post-covid recovery and then the market that has evolved from initial relatively minor concerns over supply chains to the perfect storm of economic and political factors we see combining today, writes Andy Thomson.

Through it all, Ewald’s team has been guided by a macroeconomic group within Bain Capital that provides in-depth updates in areas such as inflation, interest rates, manufacturing indices and expert opinion. The group’s updates over the last 12 months have not exactly been bright and breezy, but Ewald acknowledges they’ve been accurate “so it’s been useful to have that macro perspective backing up our investment decisions”.

The Bain private credit group has around $9 billion of assets under management, the majority of which is focused on senior debt and a minority on junior capital. The deal focus is on what Ewald describes as the “core middle market” of businesses with EBITDA in the $25 million to $75 million range. Although Bain is in the top 10 of alternative asset managers globally by size (around $160 billion AUM), Ewald says the firm is not like publicly traded peers in needing to keep growing AUM by raising ever-larger funds.

“They’ve moved more upmarket to compete with the syndicated market. As a private partnership, and the largest single investor in all of our funds, our singular focus is on generating attractive returns for our LPs,” insists Ewald. “We’ve stuck to our knitting and tended to raise fund sizes that make sense for our market segment.”

Lack of conviction

The growing macroeconomic pressures have not resulted in a market shutdown, according to Ewald, but he’s detecting a certain ‘going through the motions’ as fund managers lack conviction in seeing deals to the finish line. “Sponsor activity is more elevated than we would have expected given the economic backdrop but, at the same time, sponsors seem a little more technical and cautious. They’re making bids that are sometimes on the low side, and with opt-out clauses.

“There have been some disappointing valuations from the sellers’ perspective because they’re looking at what the business might have sold for six or nine months ago. So, we’ve seen an increase in deals being pulled from the market – especially sponsor-to-sponsor deals.”

Ewald says Bain Capital is still active but necessarily selective. “A business services company or a software company that’s making things faster, cheaper or more efficient for other companies to operate is likely to perform well in any kind of economic backdrop, so we’ll continue to do those deals. But for anything with exposure to fluctuating demand, there’s a very high hurdle.”

Europe faces a storm

He adds that this hurdle especially applies to Europe at the current time, given that the region appears to be in the eye of the economic and geopolitical storm. The normal ratio in terms of deal activity for Bain is around 75 percent US, 20 percent Europe and 5 percent Australia.

Last year, in the face of what appeared to be an overheated market in the US, the European proportion rose to around 40 to 45 percent. Ewald says the respective numbers have now come back down to their more normal levels.

Asked whether deal terms are shifting in favour of lenders, Ewald says the firm has always strongly advocated for the presence of financial covenants and that – while insisting on them may have been a deal-breaker in the past – few borrowers are resisting their presence now (it would probably be futile).

There are other areas where Ewald sees lenders able to flex their muscles again after the borrower-friendly environment that prevailed last year. For example, few sponsors are now able to re-leverage companies up to the full amount of closing leverage with re-leveraging now restricted to a half-turn or even a full turn less than the closing amount. Ewald also notes that attitudes to restricted payment baskets have changed with management fees acceptable, but the likes of expenses, transaction fees and dividends harder to justify.

Another borrower-friendly development is the ability to revisit, and obtain favourable changes to, the documentation of existing deals. This may be done, for example, when businesses need new financing for add-on acquisitions.

Determined to ‘stick to the knitting’, Ewald is not tempted to switch substantially to non-sponsored deals in the face of the higher bar for sponsored deals. His team’s senior deals are currently around 90 percent sponsored, while for junior the figure is around 60 to 70 percent.

“You could argue they provide a risk premium but we would argue that has been largely competed away. A lot of new entrants have come into the market at the lower end, so that’s a very crowded space. And now, layered on top of that, there are concerns around economic slowdown, a recessionary environment and rising rates. Often, these are businesses that would benefit from professional management teams.”

The Bain Capital view of sectors

Ewald says favoured sectors include business services and technology. But if neither of those is too surprising, he does have a left-field addition. “We like aerospace and defence where we have very strong industry coverage and it’s cyclical but not economically cyclical – it has longer and broader cycles.”

Healthcare is a sector Bain Capital Credit has actively invested in historically but is more cautious about now. “It didn’t prove to be as resilient post-covid as expected.”

On the other hand: “We view the distribution and logistics space as attractive, especially in a growing e-commerce environment. Getting goods to consumers in a timely manner is more important than ever.”