Tick, tick, boom

Critics of the private equity industry often point to its aggressive use of leverage, and there is no shortage of struggling companies to cite as examples of the perils of over-gearing. But if you thought the industry had gone cold-turkey when it comes to gearing, a new report suggests otherwise, at least on one side of the Atlantic. It bodes ill for the future.

A report this week showed a pronounced trend in buyout financing. Debt-to-enterprise value multiples for buyouts were on a marked downward trajectory in Europe. The problem? On the other side of the Atlantic, the exact opposite has been occurring.

In the US, according to the report from data provider CEPRES, median equity/EV has fallen from 0.40 in 2008 to 0.31 last year (with debt/EV rising accordingly). That figure was a record low, less than the 0.35 for 2004-2007, the period widely acknowledged as the ‘golden era’ of private equity when debt was cheap and plentiful and leverage soared accordingly.

In Europe, equity components have done the opposite, rising from 0.32 in 2005 to 0.46 last year.

So what’s the reason for this trans-Atlantic schism? Private Debt Investor chaired a panel of European debt practitioners this week, kindly hosted by law firm Latham & Watkins. For detailed coverage of the event, you’ll need to read the November issue of PDI magazine, but there were some interesting views expressed about the differences between the European and US markets.

The US has a far more developed non-bank financing market and its high yield bond and CLO markets have been in rude health. Consequently, liquidity in the US has far exceeded that in Europe. The breadth and depth of the US market has even led to European borrowers (often quite a parochial bunch) to seek it out as an alternative source of financing.

Panellists on the round table spoke of the ‘generous’ covenants attached to US deals, some with a wistful look in their eye. US banks have been more aggressive on the whole at cleaning up their balance sheets, freeing them up to lend in greater volumes.

This is great news for sponsors of course, and it will be interesting to see if the full year 2013 M&A and buyout data support the view that increased liquidity has led to a marked uptick in deal volumes. But it does raise concerns about whether sponsors and the lending community have heeded the salutary lessons of the crisis: anecdotally, the loose covenant structures and generous leverage multiples would suggest that perhaps they haven’t been taken to heart quite as they should have been.

Whilst leverage is rising in US buyouts, it’s not an issue which will be at the forefront of everyone’s mind in the short term. A far bigger problem is looming – the US debt ceiling.

The US House of Representatives has just six days to reach a consensus on raising the self-imposed limit to governmental borrowing, else the US risks the unthinkable: default.

For a country and currency that has long been the safest port in a storm, the economic repercussions of such a default will be felt far afield. The brinkmanship occurring between US politicians at present cannot last – and the PDI house view is that the ceiling will be raised because a default is simply too apocalyptic an outcome to countenance – but it’s nonetheless a disturbing sideshow as the world’s economies limp out of a recession. The drama unfolding over the next six days will make for fascinating viewing.