The slump in the leveraged loan market is cutting the amount of debt buyout firms are able to raise for European acquisitions to a decade-low, threatening the returns they reap from the investments.
Loans being marketed in Europe last week represent debt of 4.4 times earnings before interest, tax, depreciation and amortization of the target company, according to data compiled by Bloomberg. That’s the lowest since at least 2001 and below the 2011 average of 4.8 times, according to Fitch Ratings.
Europe’s deepening deficit crisis has sapped demand for high-risk debt, prompting 3i Group Plc and Axa Investment Managers Private Equity SA to target smaller loans than the norm for buyout-funded acquisitions. The more money buyout firms have to put into a deal, the lower their return on equity.
“Banks have to delever, funds are seeing better value in the secondary market, and the economy is in a dire state,” said Jon Moulton, London-based chairman of Better Capital LLP, a distressed company investor. “Returns for private-equity funds will need to come down to mid-teens from over 20 percent.”
The equity contribution buyout firms needed to put into their deals last week rose to more than half, up from a 36.5 percent quarterly average this year, according to Fitch.
Borrowing costs for buyout firms in the loan market have risen to an average 4.3 percentage points more than benchmark lending rates, up about 0.2 percentage point since the first half of the year, Bloomberg data show.
Axa Private Equity is raising 240 million euros ($327 million) of senior loans for its buyout of photo sensor technology provider Photonis Technologies SAS, arrangers of the deal ING Groep NV, Societe Generale SA and IKB Deutsche Industriebank AG said in a statement on Sept. 8.
Debt to Merignac, France-based Photonis represents less than half the purchase price, and pays as much as five percentage points more than the euro interbank offered rate, according to Bloomberg data.
3i is raising 205 million euros of senior debt to acquire Paris-based building fastener maker Etanco, according to Bloomberg data, also less than half the purchase price.
Estelle Guillot-Tantay, a spokeswoman for Paris-based Axa, didn’t immediately comment. Kathryn van der Kroft, a spokeswoman for London-based 3i, declined to comment.
“We are not changing our return expectation,” Yalin Karadogan, a London-based principal at Cinven Ltd., said Sept. 8 in an address at a leveraged finance conference organized by Euromoney Seminars in London. “The big challenge for the private equity industry now is how to achieve return in a lower-debt, lower-growth environment. Strong growth is achievable with the right strategy, regardless of the economic environment.”
On the secondary market, the spread for leveraged loans rated BB rose to 4.2 percentage points from 3.3 percentage points three months ago, while B rated deals jumped to 5.7 percentage points from 4.42, according to Markit Group Ltd. data. Leveraged loans are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s and Fitch.
Economic growth in the euro region slowed to 0.2 percent in the second quarter from 0.8 percent in the first three months of 2011 as governments cut spending to contain the spreading deficit crisis.
“We will have a slow or no growth situation in Europe in the next six to 12 months,” said Tanneguy de Carne, head of non-investment grade debt capital markets at SocGen in London. “LBO financing of less than 500 million euros will have a better chance of getting done successfully in the next few months. Banks are becoming a lot more cautious in underwriting deals.”