Buyout debt returns to pre-crisis levels in US

October 8, 2013 6:38 pm

Buyout debt returns to pre-crisis levels in US

By Anne-Sylvaine Chassany, Private Equity Correspondent

The amount of debt in US leveraged buyouts has increased to levels reminiscent of the boom years before the financial crisis, as private equity groups tap buoyant credit markets. Private equity investors aim to boost their returns by using more bank debt or bonds than their own cash to fund takeovers. By the end of September, the debt component in US deals, which is serviced by the profits of the purchased companies, equalled 5.3 times the companies’ earnings before interest, taxes, depreciation and amortisation (ebitda), according to S&P Capital IQ. This is the highest ratio since 2007, when the average debt portion reached a peak of 6 times ebitda, and surpasses the 2006 level of 5.1 times.Six years ago, such ratios were symptomatic of a credit bubble, leaving companies including educational publisher Cengage , British music company EMI and US power utility Energy Future Holdings struggling with high debts after the crash.

Buyout groups have been able to take on more debt thanks to the growing number of yield-starved investors moving into riskier securities, such as high-yield bonds. The decision by the US Federal Reserve, two weeks ago, not to taper its $85bn monthly bond purchases has supported this rush by keeping interest rates at historic lows.

Most big buyouts have tapped these welcoming credit markets to delay debt maturities, avoiding default. But leverage mechanically makes companies more vulnerable to economic hiccups or a sudden rise in interest rates.

Some dealmakers and bankers say that overly accommodating credit markets are also starting to lift valuations artificially.

“This is pushing prices of assets upward, it’s very difficult to find a good risk-reward balance in the US right now,” says Raymond Svider, New York-based managing partner at buyout group BC Partners.

Mr Svider says debt frequently amounts to 6.5 to 7 times ebitda in US deals now, reaching 7.5 times in some cases. The $6bn acquisition of Neiman Marcus by Ares and Canada Pension Plan Investment Board is expected to leave the US department store with a debt of about 7 times ebitda.

Debt is also on the rise in Europe, albeit from lower levels: 4.7 times ebitda on average this year, compared with 6.1 in 2007. However, the highest ratios were achieved by European deals, including CVC’s €3.1bn buyout of German metering company Ista – at 7.25 times ebitda – and Cinven’s acquisition of German ceramics maker CeramTec, at 7 times.

So far, the impact on prices has not translated into hard data. Valuations have slipped to 8.4 times ebitda in the US this year, from 8.7 times in 2012, according to S&P. But they exceed the 2006 average, suggesting prices are high by historical standards.

“The anecdotal evidence from [private equity groups] tells us that they see deals being completed at higher multiples and that they are losing them,” says Mario Giannini, chief executive of Hamilton Lane, which advises private equity fund investors.