Momentum for a recovery in LBO activity slowed in the second quarter, as higher entry multiples coupled with a historically high cost of debt funding limited the playbook for private equity value creation.
While the stand-off in exit activity continues to slow the redeployment of capital, sentiment indicators and record levels of demand from investors point to a favorable backdrop for the return of dealmaking.
At the year’s halfway mark, the key highlights of LCD’s analysis of the credit stats of LBO deals clearing the broadly syndicated loan market are as follows:
- Purchase price multiples averaged 11x in H1 2024.
- Yields on new LBO loans fell from 2023 highs.
- Loan issuance funded sponsor dividends at a record pace.
- Amid higher rates, interest coverage remained below 3x.
Private equity sponsors tapped $36 billion of funding for LBO transactions in the syndicated loan market during the second quarter, down from roughly $45 billion in the previous quarter and 31% lower than Q2 2023. On a year-over-year comparison, H1 2024 volume was $81 billion, up from $76 billion in H1 2023.
Activity to finance LBO deals fell well short of the $98 billion in Q1 2022, before rate hikes kicked in. For reference, average LBO transaction activity stood at $50 billion per quarter in the 10 years through 2021, including $64 billion per quarter between 2017 and 2021.
Demonstrating the depth of demand for sponsors willing to tap debt markets in the higher rate environment, UK-based Darktrace (B-/B3/B) helped bolster the LBO figures for July with its $1.735 billion first-lien and $410 million second-lien term loans. The loans back Thoma Bravo’s take-private buyout of the cybersecurity firm for roughly $5.3 billion.
In the shifting sands between broad syndication and private credit, nearly 90% of Q2 transactions funded in the latter, maintaining the dominance of private credit financing when measured by deal count.
With the expansion of direct lending that historically has focused on smaller-sized deals, LCD data shows a clear reduction in smaller LBO transactions within broadly syndicated markets.
In 2019, 62% of all BSL deals supporting buyouts funded transactions of at least $1 billion, based on total debt and equity, up from 49% in 2018. By 2023, this share had risen to a record 84% and it swelled again in H1 2024 to 86%.
Flipping that analysis, pre-pandemic, nearly 40% of BSL-funded buyouts were for less than $1 billion in 2019, and so far this year, less than 15% are for transaction sizes of less than $1 billion.
Given the challenging exit environment limiting the ability of private equity firms to realize profits from portfolio sales, sponsors have looked to extract dividends instead.
The first half of 2024 brought a heady pace of loan issuance to fund dividends. A total of $35 billion of institutional loan issuance funded dividend recapitalizations in the first half of the year, outpacing the same period in 2021, a record-setting year for dividend issuance.
A shift in risk tolerance was evident last quarter, as fewer companies with riskier B-minus ratings came to syndication.
In the second quarter, only 15% of LBO borrowers carried a B-minus rating, or a rating on the cusp of triple C. This was down from 36% in Q1.
Pre-rate hikes, in 2021, the B-minus share of deals was 56%. By 2023, this had fallen to just 5%.
As higher debt costs erode interest service coverage, investors have sought out companies with an added buffer for weathering high interest costs. In Q2, 85% of companies funding LBO transactions in the institutional loan market carried a rating of single-B or higher, up from 57% in Q1.
At 2.37x, interest coverage for newly minted transactions financed in the leveraged loan market in the first half of the year was nearly unchanged from 2023, which booked the lowest annual reading since 2007, at 2.36x.
With the uptick in higher quality credits clearing the market and a persistent net supply shortage, the average new LBO loan offered a spread of S+364 last quarter, the lowest quarterly reading since 2007 and down from S+388 in the first quarter. The cost of funding over the base rate has fallen 170 bps from Q3 2022, when it reached a 10-year high of 534 bps.
Furthermore, the original issue discount offered to par improved slightly in the borrower’s favor, to 99.4, from 99.2 in the first quarter, demonstrating a normalization of markets versus OIDs in the 96% area in 2023 and 2022.
In yield terms, which includes the base rate, spread and original issue discount, LBO deals cleared the market at 9.41% on average in Q2, down from 9.71% in Q1. Though off the record high of 12.4% in Q4 2023, the latest yield is still double the record low of 4.7% set in Q1 2021.
Leverage levels increased in the first half to 5.3x, from 4.9x on average last year. Outside of 2023, leverage levels are the lowest they’ve been since 2012.
Higher leverage levels have allowed equity contributions for LBO transactions to ease from a record high in 2023, when private equity firms were forced to offer an equity infusion of more than half the funding mix. In H1 2024, the average equity contribution fell to 47%, from 51% on average in 2023.
Finally, higher purchase price multiples are squeezing the LBO math at a time when the cost of debt capital remains high in historical terms. Deals tracked by LCD in the first half show that the average purchase price multiple rose to 11.1x, from 10.8x in 2023, which was the lowest level in five years.
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