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Study: Niche mid-market credits a safer bet

A new study of over 500 mid-market companies in EMEA by credit ratings agency Standard & Poor’s finds that mid-size sponsor-less companies hold more vulnerable business positions but make up for it with financial conservatism.

A survey of the credit worthiness of 547 mid-market companies showed that most were clustered around measurements equivalent to a BB or B rating by Standard & Poor’s (S&P), the credit ratings agency that conducted the research. The survey was the first by the agency to use data to confirm the widely held market view that mid-market leveraged buyout (LBO) companies use less leverage and produce better cash flow than their large-cap equivalents, said Claire Mauduit-Le Clercq, one of the primary credit analysts who worked on the report. 

The report highlights the difference in mid-market and large-cap LBO funds from operations (FFO) ratios. The mid-market LBOs analysed had average FFO of 10.6 percent versus 7.3 percent for larger LBOs. The difference is particularly visible in the UK market, the report shows, with FFO of 10.6 percent and leverage multiples of 7.7x for mid-cap while the equivalent measurements for larger LBOs are 4.4 percent and 10x, respectively. 

S&P has built a separate metric for the sector called the mid-market evaluation (MME). MM3 and MM4 roughly correspond to a BB rating from the agency while MM5 and MM6 can be read as a B grade rating. Those four categories cover a significant majority of the companies in the study with a few clustered in the upper, MM1/MM2 end with more sitting in the lower MM7 and MMD categories. There is a clear division between leveraged buyout companies and sponsor-less credits with the latter concentrated in the BB-equivalent MM3 and MM4 categories (though the MM5 category holds around 80 sponsor-less companies). Around 130 LBO credits were classified as MM5 (B) while another 90 made it into the category below that. 

Non-LBO credits tend to have a more exposed business position, the report said, but make up for it with more conservative financial profiles. A large number also benefit from niche market positions. 

The analysis also confirmed the market view that there is a stark division in mid-market credit quality by sector, explained Mauduit-Le Clercq. She noted that sectors where scale is less important and it is possible to shelter from competition sit higher up the credit curve. Such sectors include machine and equipment manufacturing, consumer goods, and specialized high tech sectors, according to the report. The upper end of the scale, MM1 to MM3, encompassed 11 percent of the companies assessed. 

Less protected sectors broadly represented on the lower end of the scale, MM4 to MM6, include retail, media, and leisure. These businesses displayed weaker credit metrics with high operating leverage and limited scale, the report said. 

Most of the new companies rated by S&P over the last few years are mid-market credits, Mauduit-Le Clercq noted. Some are motivated by a desire to tap alternative financing markets such as direct lenders, or the European private placement German schuldschein markets. 

The majority of the companies included in the survey, 46 percent, had revenues of less than €300 million. Another 36 percent reported revenues of between €300 million and €800 million while the remaining 18 percent had revenues of over €800 million up to €1.5 billion and outstanding debt of less than €500 million. The regional distribution included a minority from the Middle East and Africa (12 percent). Germany, at 18 percent of the firms, was the only country singled out in the regional breakdown. The UK, Ireland and the Nordic countries made up 28 percent of the companies included with France and the Benelux region accounting for 26 percent.