This article examines some of the most significant buyouts to have taken place in Europe and the US between October 2009 and April 2010 and the trends they reveal about the transactional private equity market in the aftermath of the financial crisis.
Private equity houses endured an extremely challenging year in 2009. Based on data collected by Bloomberg, the global value of private equity M&A in 2009 was US$80 billion (about EUR58.1 billion), substantially less than the US$664 billion (about EUR482.4 billion) worth of deals that took place in 2007.
Despite an overall gloomy year, M&A activity began to recover during the fourth quarter of 2009 (Q42009), which saw a 32% increase in global deal volumes in relation to the previous quarter, partly thanks to a thaw in the lending markets. Improved access to debt allowed private equity funds to close some of the largest leveraged buyouts (www.practicallaw.com/4-200-1393) (LBOs) of the past two years during this period.
In light of these developments, commentators predicted that substantial private equity-backed acquisitions would make a comeback in 2010 after an almost two year gap. These predictions have proved true so far. According to KPMG, during the first three months of 2010, there were 36 buyouts in the UK, worth a total of GPB5.14 billion (about US$7.8 billion), the highest value and volume for seven quarters (see KPMG, News release, UK mid market private equity houses drive leap in Q1 deal activity).
Improved access to leverage and the difficulties that some private equity funds have encountered when trying to divest of their portfolio companies through an IPO have also resulted in an upsurge in secondary buyouts (www.practicallaw.com/9-382-6070). Indeed, the value of secondary buyouts rose to US$4.2 billion (about EUR3.07 billion) during the first two months of 2010, a 13-fold increase on the equivalent period in 2009, according to Dealogic.
This article examines the current private equity transactional landscape in Europe and the US. In particular:
Private equity's capital overhang and the resulting competition for deals.
Latest debt finance trends in US and European buyouts, including:
decreasing debt to equity ratios in comparison to pre-2008 levels;
more deal certainty provisions;
pre-deal syndication; and
Leading practitioners' predictions for the private equity market for remainder of 2010.
Private equity houses worldwide have an estimated US$500 billion (about EUR367 billion) of unspent committed capital ("dry powder), which they raised before the credit crunch and were unable to deploy during the crisis due to a combined lack of leverage and suitable acquisition opportunities . For background on the downturn's impact on private equity, see Practice note, Private equity: the impact of the financial crisis (www.practicallaw.com/2-500-8882).
Traditional buyout funds have a usual lifespan of ten years, of which the first five to six years comprise the investment period. A fund manager is usually barred from making new investments without the consent of investors after the fund's investment period ends. For a comparison of the common investment objectives of private equity funds in different jurisdictions, including the average life of a fund, see Private Equity Handbook, Q&A tool, Question 12 (www.practicallaw.com/7-500-9935).
80% of UK fund managers polled in a recent survey by Grant Thornton, the accounting and corporate advisory firm, had at least one quarter of their latest fund left to invest. 27% of respondents had over three quarters left to invest (see Grant Thornton, Press release, 71 per cent of private equity firms expect rising deal flow in 2010 as debt markets thaw).
As Chris Hale, head of the corporate department at Travers Smith notes: "The buyout market has been a bit like the property market in the sense that prices have risen in recent months, partly due to a shortage of supply." Private equity sponsors have an estimated US$86 billion (about EUR63.9 billion) tied up in funds raised between 2004 and 2006, which they need to invest in deals with an enterprise value of at least GBP100 million (about US$151.8 million) before the looming expiry of these funds' investment periods. This pressure to put capital to work, combined with improved, but by no means optimal, access to debt (which makes it complicated to do megadeals at present), has resulted in intense competition for good quality assets in the mid-market, upper mid-market and lower reaches of the big-ticket market.
The fierce competition for good quality assets stemming from private equity's capital overhang could be artificially driving up the prices of mid-market targets. According to Bain & Co, the management consultancy, many firms are "bidding up prices and settling for a lower target internal rate of return (www.practicallaw.com/8-107-6721) (IRR) in order to win investments" (see Bain & Company, Global Private Equity Report 2010). For an introduction to the concept, use and calculation of IRR as a measure of performance in private equity investments, see Practice note Internal rate of return (IRR): an introduction (www.practicallaw.com/6-384-9563).
Failure to invest capital before the end of the investment period can lead to a fund being shrunk or prematurely terminated. Either of these events can jeopardise the likelihood of attracting investors when a private equity house raises a new fund, particularly given how difficult the fundraising market is at present.
According to Preqin, the research and information firm, the global value of private equity fundraising in 2009 was US$246 billion (about EUR178.9 billion), a 61% fall from the previous year. Moreover, unlike transactions and exits, there were no signs of recovery in Q42009 - fundraising actually saw its worst performance since 2003 during this quarter. While the fundraising climate has remained tough in early 2010, some private equity sponsors, such as 3i, which raised a EUR1.2 billion (about US$1.6 billion) fund in March 2010, have bucked the wider trend.
In addition to allocating less capital to private equity than before the crisis, investors in private equity funds, which now enjoy a stronger bargaining position vis-a-vis fund managers, have recently imposed tougher terms on news funds. For instance:
Stricter carried interest and management fee provisions.
Stronger key person terms, exclusivity and removal clauses.
Enhanced investor involvement in the management of the fund through the use of investor committees and supervisory boards. For an overview of the key protection measures that investors in private equity funds seek in different jurisdictions, see Private Equity Handbook, Q&A tool, Question 10 (www.practicallaw.com/7-500-9935). For a more detailed analysis of these recent fundraising trends, see Article, Fundraising post credit crunch. (www.practicallaw.com/0-501-1423)
According to some commentators, the gloomy fundraising landscape could be the prologue of a Darwinian overhaul of the private equity industry. A recent report by Partners Group, the asset management firm, predicted that a third of buyout groups would be unsuccessful in raising meaningful amounts of additional capital for future funds and would eventually dissolve (see Partners Group Research Flash, The New Buyout: How the financial crisis is changing private equity).
While most lawyers' forecasts are not as pessimistic, there is acknowledged speculation in the legal market about when private equity fundraising will resume, coupled with concern about the survival prospects of some existing players over the next couple of years.
For an overview of current regulatory, tax and commercial hurdles affecting private equity fundraising, see Article, Fundraising post credit crunch, 1 October 2009 (www.practicallaw.com/0-501-1423).
In light of the need to put capital to work, it is hardly surprising that, since Q4 2009, buyout houses have taken advantage of the gradual modest improvement in the availability of credit to invest some of their "dry powder".
The next section examines four of the most significant recent private equity transactions and the trends they reveal about the ways in which post-crisis buyouts in the US and Europe are being financed and structured. The deals examined include:
The public-to-private of IMS Health.
The acquisition of Marken.
The buyout of Springer Science and Business Media.
The acquisition of Pets-At-Home.
On 5 November 2009, TPG Capital (TPG) and the Canada Pension Plan Investment Board (CPPIB) announced the acquisition of NYSE-listed IMS Health for US$5.2 billion (about EUR3.8 billion), including US$1 billion (about EUR727 million) of existing debt. As at 1 May 2010, this transaction remains the global high water mark in LBOs since the worsening of the financial crisis in mid-2008.
For a summary of this transaction, see PLC US What's Market, TPG Capital and IMS Health Incorporated merger.
Decreasing debt-to-equity ratios. The IMS acquisition was partly financed with US$3 billion (about EUR2.18 billion) of debt, divided into:
A US$2 billion (about EUR1.45 billion) senior secured term loan (www.practicallaw.com/8-107-7382).
A US$1 billion (about EUR727 million) unsecured term loan.
The financing package was supplemented with a US$275 (EUR206) million revolving credit facility (www.practicallaw.com/7-107-7170) (RCF).
TPG and the CPPIB financed almost half of the deal with their own equity. The level of gearing (www.practicallaw.com/0-107-6640) in recent US and European public-to-private transactions has fallen to around 50%, compared to about 70% debt to 30% equity before the credit crunch.
Deal certainty provisions. The IMS merger agreement (www.practicallaw.com/6-500-7098) included a reverse break-up fee of 5.29% of the total deal value, which was considerably larger than the target's break-up fee, which ranged between 1.54% and 2.21%. The widening gap between break-up fees and reverse break-up fees in some large-cap US M&A indicates a trend among certain US sellers to negotiate contractual provisions that enhance deal certainty.
Other clauses in the IMS agreement also evidence the seller's pursuit of certainty, including:
A restriction on the buyer's ability to rely on the reverse break-up fee for events of financing failure, with specific performance otherwise available to the target if:
the closing conditions are otherwise satisfied;
the debt financing is available; and
the company can "irrevocably confirm" that the deal would close if the equity and debt financing were consummated.
A right for the company to cause the shell-company buyer to pursue the equity financing from its sponsors if the debt financing is available.
A 45-day go-shop (www.practicallaw.com/5-383-2191) for the target. Go-shop clauses enable the target company or seller in an acquisition or merger to actively seek, discuss and negotiate an alternative transaction with a third party for a specified period of time, usually 30-60 days. For an overview of go-shops and other related clauses, such as "no-shops" and "window-shops", see PLC Corporate & Securities, Practice note No-shops and Their Exceptions (www.practicallaw.com/8-386-1078).
As further evidence of this trend, the US$2.4 billion (about EUR2.72 billion) proposed acquisition of Cedar Fair LP by affiliates of Apollo Global Management LLC, contained deal certainty provisions broadly similar to those in the IMS agreement, including:
Similarly-worded termination, reverse break-up fee and specific performance provisions (including the "irrevocably confirm" condition for specific performance).
A reverse break-up fee of US$50 million (about EUR37 million), or 2.08% of the total value compared to a sellers' break-up fee ranging between US$11.4 million (about EUR8.4 million) and US$19.6 million (about EUR14.5 million) or 0.47% to 0.81% of the total deal value.
A 40-day go-shop period.
The Cedar Fair transaction ultimately collapsed due to pressure from a group of activist shareholders who believed that the offer price was too low.
For a summary of this transaction, see PLC US What's Market, Apollo Management and Cedar Fair, L.P. merger.
For additional information on recent trends in the US buyout market, see Article, Private Equity in 2009: A Year of Transition, 7 January 2010 (www.practicallaw.com/8-501-1725), IMS Health: Reverse Break-up Fees, Financing and Deal Certainty in a New Era of Private Equity, 23 November 2009 (www.practicallaw.com/3-500-6967) and Article, Reverse Break-up Fees and Specific Performance: A Survey of Remedies in Public Deals (www.practicallaw.com/7-502-1268).
A similar trend in Europe? European practitioners have not encountered similar deal certainty clauses so far. David Sonter, a private equity partner at Freshfields Bruckhaus Deringer, suggests that this could be because European LBOs tend to be structured in a different way: "In the US, completion is generally subject to a financing condition. If this condition is not met, the buyer pays a reverse break fee as compensation to the seller. In contrast, European buyouts are stricter in requiring that unconditional debt and equity financing are in place on exchange, partly due to the influence of the 'certain funds' requirement in the UK Takeover Code having become widely applied even in private deals." For background on the certain funds requirement, see, Practice note, Financing an offer for a public company: the certain funds requirement (www.practicallaw.com/5-370-3957).
Sonter further notes that during the height of the crisis, there was speculation as to whether the UK market would move closer to US-style deals. However, ultimately it appears that European sellers "simply do not want to be exposed to the possibility of the transaction not closing," he says.
According to David Innes, a private equity and M&A partner at Travers Smith, the terms of UK buyouts, particularly those arising out of a competitive auction process and involving high quality businesses, have not changed much despite the developments of the past two years. Innes notes: "Buyers will always compete for high quality assets, which will ultimately allow sellers to achieve good exits." For background on the key stages and documentation of a private equity transaction, see Practice note, Acquisition of the business: private equity (www.practicallaw.com/7-107-4322).
On 7 December 2009, a consortium comprising funds advised by Apax Partners (Apax) and the target company's management announced the acquisition of Marken from Intermediate Capital Group (ICG) for GBP975 million (about US$1.5 billion), at that time the biggest buyout in the UK for over a year.
Equity underwriting. A noticeable feature of the transaction was the fact that Apax underwrote the deal entirely with its equity from its EUR11.2 billion (about US$14.3 billion) Apax Europe VII fund . According to Hale, who was one of the lead partners advising the sellers, equity underwriting, whereby the buyer initially finances the deal on an all-equity basis and then obtains debt finance from banks and other lending institutions after completion, is becoming more common.
Apax subsequently raised GBP315 million (about US$486 million) in debt (roughly four times Marken's earnings before interest, taxes, depreciation and amortisation (EBITDA (www.practicallaw.com/6-202-0767)), which, according to Bloomberg, was divided into:
GBP150 million (about US$231 million) of six-year term loans with an interest margin of 4.5% above benchmark rates.
GBP150 million (about US$231 million) seven-year debt with a 5% spread.
GBP15 million (about US$23.1 million) seven-year revolving credit with a 4.5% spread.
As Hale explains, "The advantage of the buyer assuming the risk of the debt not being available is that, instead of having to go cap-in-hand to potential lenders with relatively limited liquidity before the acquisition (which gives them greater control over the terms), it can do so after having acquired a very good company, which considerably improves the buyer's chances of driving more favourable terms from the different lenders."
Besides Marken, at least two recent private equity sponsors in the UK have used equity underwriting as an acquisition finance method, notably:
Permira's GBP228 million (about US$350 million) acquisition of Just Retirement (Holdings) plc. For a summary of this transaction, see PLC What's Market, Permira Advisers LLP offer for Just Retirement (Holdings) plc.
Exponent Private Equity's purchase of a majority stake in the Ambassador Theatre Group for GBP90 million (about US$138 million).
On 11 December 2009, EQT Partners AB and the Government Investment Corporation of Singapore (GIC) announced the acquisition of Springer Science and Business Media from Cinven and Candover for EUR2.3 billion (about US$3.1 billion), at the time the largest European buyout in over a year.
The sale of Springer was, reportedly, partly motivated by the sellers' goal of reducing the target's EUR2.2 billion (about US$2.9 billion) of debt, some of which was due to mature in 2010. Cinven and Candover had refinanced the company three times prior to disposal, which enabled them to generate returns of about 1.6 times their combined EUR600 million (about US$808.5 million) initial equity investment.
Reducing debt has been one of the key motives behind several recent private equity exits and, according to some practitioners, one of the reasons behind the tepid reaction of institutional investors to some recently-announced IPOs of companies backed by private equity in the UK.
EQT and the GIC financed the Springer buyout through a combination of the following:
A EUR550 million (about US$741.2 million) combined equity investment, 82% of which was provided by EQT. This capital injection repaid some of Springer's debt at par (www.practicallaw.com/7-200-1400).
EUR1.72 billion (about US$2.31 billion) of new debt, the largest European private equity-sponsored leveraged loan financing package arranged since late 2008, which four of the company's biggest existing lenders provided, underwrote and syndicated.
Springer's new capital structure has several advantages:
Lenders received a partial repayment on existing debt at face value and higher interest payments on the new debt.
Sellers received substantial returns.
Springer ended up with a healthier capital structure.
Pre-deal syndication. Ian Frost, a finance partner at Freshfields Bruckhaus Deringer who advised on the financing aspects of the Springer buyout, notes that, due to the current limited availability of investors (in particular) collateralised loan obligation (www.practicallaw.com/7-385-1862) (CLO) and collateralised debt obligation (www.practicallaw.com/9-385-1842) (CDO) structures, lenders are increasingly pre-distributing M&A deals before buyers and sellers begin negotiating: "The Springer buyout was heavily pre-sounded and pre-syndicated. Moreover, the parties began negotiating without relying on term-sheets, which made the documentation process much more complex and marked by the use of several heavy flex-type arrangements".
According to Sonter, the Springer acquisition evidences the trend towards greater integration between the corporate, financing and M&A elements of LBO transactions. "Before the crisis, you used to be able to do the equity, financing and M&A aspects of buyouts in almost separate streams. However, current financing conditions have given rise to a greater need to coordinate all aspects of the transaction. You need a fully formed acquisition finance process before considering the share purchase agreement. Acquisition finance is much more prominent and is becoming relevant at earlier stages in the transaction".
Stapled financing. Springer's existing senior lenders played a key role in its acquisition. The financing of the transaction was, however, more complex than a straightforward deal involving old lenders providing new leverage. "The acquisition finance was effectively developed from the company's existing debt, which enabled the parties to use existing terms," explains Frost.
According to Frost and Sonter, this kind of stapled finance (www.practicallaw.com/4-386-5361) arrangement is the order of the day in European private equity deals. As Frost explains, "Three years ago, a seller in a competitive auction could expect half a dozen fully-financed bids, whereas nowadays they cannot usually get more than one or two bidders with underwritten debt packages. The relative thinness of the debt markets has caused a move towards arranging the debt on the sell-side. Against this background, stapled financing ensures that competitive tension is maintained throughout the auction."
Kohlberg Kravis & Roberts's (KKR) acquisition of Pets-at-Home (Pets) for GBP955 million (about US$1.45 billion) in late January 2010, offers a practical illustration of the relative merits of a secondary buyout over an IPO from a private equity seller's perspective. The acquisition followed an intensely competitive auction process, which the sellers, Bridgepoint, ran alongside IPO preparations.
The GBP955 million (about US$1.45 billion) consideration, which included GBP233 million (about US$354.9 million) of existing debt, valued Pets at 2.4 times annual sales and was reportedly at the top end of the company's IPO valuation range. It also generated a return of eight times its initial equity investment for Bridgepoint, which acquired Pets for GBP230million (about US$350 million) in 2003.
KKR raised acquisition debt to the value of GBP485 million (about US$676 million), divided into:
GBP75 million (about US$114.2 million) six- year term loan paying interest of 4.5% over LIBOR.
GBP245 million (about US$373 million) of seven-year loans priced at 5% over LIBOR.
GBP30 million (about US$45.6 million) RCF due in six years with a spread of 4.5%.
GBP 135 million (about US$154 million) of mezzanine debt (www.practicallaw.com/0-107-6843).
Sponsors underwriting LBO debt. KKR Capital Markets, the buyer's debt division, was one of the deal's underwriters. Some of the largest private equity houses have recently diversified into areas such as debt investing and capital markets advisory work and regularly provide these services for their funds and portfolio companies (and occasionally for external clients). Whereas KKR chose to diversify organically, Blackstone, another major private equity house, did it indirectly through its 2008 acquisition of GSO, a hedge fund specialising in leveraged finance.
IPO versus an auction process. Bridgepoint's decision to sell Pets instead of floating it illustrates the commercial advantages of an auction process over an IPO from a seller's point of view. These advantages include price certainty and a clean exit. The outcome of the Pets transaction was influenced by the fragile state of the public markets throughout late January and February 2010, a fragility which coincided with the point at which the company had to decide which track they were going to follow. As Hale explains "If there is uncertainty in the equity markets and a seller receives a very good offer for a sale, it is quite difficult to turn it down because a sale will give the seller certainty and a 100% exit, normally very quickly". He contrasts this position with an IPO, where the private equity owner will usually be required to enter into a lock-up agreement with the underwriter(s) barring the disposal of shares in the company for a given period post-IPO (generally between six and twelve months). For further background on lock-up agreements see Practice Note, Private equity exit routes (www.practicallaw.com/4-107-4314).
In addition, an auction process gives the seller greater certainty and control over the final price, unlike in an IPO, which leaves the company vulnerable to the fluctuations of the public markets. Market volatility was one of the reasons cited by several private equity-owned companies, such as Travelport, which were expected to launch an IPO during early 2010, but did not (see Travelport Holdings (Jersey) Limited IPO - IPO aborted announcement (www.practicallaw.com/2-501-5217)).
Practitioners believe that the related needs to make further acquisitions and deleverage portfolio companies will continue driving the transactional private equity market for the remainder of 2010. As Sonter notes: "It is no secret that there is still a lot of debt in portfolio companies that needs to be refinanced. This need will drive private equity sponsors to either re-finance or exit sooner rather than later. As a result, we are likely to see more IPOs of good companies, more secondary buyouts and some new money deals in sectors with strong businesses and good companies. Weaker companies, on the other hand, will be weeded out."
While the recent upturn in activity is encouraging, Hale is wary of several economic downside risks in the second part of 2010 once a new government is in place, for example, possible public expenditure cuts, tax rises and looking further ahead, possible interest rate rises. "Having said that," Hale continues, "because of the need for private equity houses to put money to work, and provided that there is not another jolt to the banks, deals will be able to be financed and good quality assets will still be sold for very good prices, which will in turn encourage sellers to put them on the market".