Private equity sponsors get creative to fund take-privates

Take-private deals are back in vogue for European private equity, with US interest in UK listed companies very much the height of fashion. But with many of the underlying conditions driving the trend having been in evidence for several months and the debt market still far from full strength, why the glut of deals now – and how are they being financed? And does the trend have further to run? PE Hub Europe spoke to senior figures across the private equity industry to find out.

The large piles of dry powder in the hands of private equity firms, coupled with low public market valuations, had for several months been tipped to spark a rush of take-private bids on European markets, particularly from those with dollars as that currency grew in strength.

But despite a few take-privates reaching the announced stage, it was only in April that private equity firms really started opened their wallets, even as the dollar’s dominance was slipping.

Firms were likely biding their time to see whether the collapse of Silicon Valley Bank (SVB) and takeover of Credit Suisse by its compatriot Swiss bank UBS, both in March, were idiosyncratic or the beginnings of a full-blown banking crisis, said several sources. When they decided it was the former, they were ready to move – particularly in the UK, where economic data has been improving and the political outlook stabilising, said Michael J Preston, partner at law firm Cleary Gottlieb, who advises private equity sponsors on their investments.

“There’s now a consensus forming that it’s a good time to strike while valuations are still low and sterling is relatively low,” he said. “There’s a sense sterling might appreciate and these deals are getting more expensive to do. The mini-bank crisis wasn’t as bad as people thought. SVB wasn’t calamitous. Bidders have been hovering and all these things combined to shift the risk-reward needle. Then when one or two go, it gives confidence to the rest of the market.”

The nature of these deals means such confidence is even more important than when manoeuvring for a private company, according to Christopher Field, co-head of law firm Dechert’s global private equity practice.

“One of the historic perceptions around take-privates is that they are much more complicated to execute with a more uncertain outcome because of the additional regulatory compliance and the greater risk of putting the company into play, which is never great if you’re a buyer,” he said. “But then as more take-privates are successfully executed, people decide it isn’t such a risk.  Over time that can create a snowball effect.”

As Preston suggested, sterling has been one of the better performing currencies over the last few months. It plunged in September following a mini-budget by the then UK government, nearing parity with the dollar, but has since climbed to be worth $1.25. But longer -term considerations have also hit valuations, added Field.

“The pound is becoming weaker in a very long-term trend,” he said. “There are quite a lot of companies listed in London that have an international business, so you get that arbitrage between the listed value in sterling and the underlying value. So that may drive stronger premiums.

“There is a perception that this is a good time, overall, to take advantage of those perceived cheap valuations. And determining the valuation isn’t as opaque as it would be on a private deal.”

Premiums on take-private bids followed by PE Hub Europe range from 33 percent all the way up to 87 percent (see table above). The highest, as one would expect, are those subject to rival bids, including Triton Partners and Bain Capital’s tussle for Finnish construction firm Caverion.

Debt shift

Another factor holding back take-privates – or any type of deals, in fact – had been the rising cost and dwindling availability of financing, as central banks raised rates in the face of rampant inflation over the last few months.

That capital markets still have not reopened fully is likely why just one of the potential deals – EQT’s bid for Dechra that values the UK-headquartered veterinary pharmaceuticals company’s equity at £4.6 billion ($5.8 billion; €5.3 billion) – is over the £2.5 billion mark.

In fact, those sizes are a signal of how private equity firms have had to get creative about financing deals, including raising debt at the fund level, said Cleary Gottlieb’s Preston, particularly as under the takeover code, bidders must be fully financed when they announce their offer.

“They’ve been looking at ways to get cash into the tent, such as lending on the asset value of a portfolio or borrowing secured on the carry stream from the underlying investments,” he said. “A number of direct lenders are providing liquidity solutions for GPs and sponsors. That can give you a line of credit to do deals, including take-privates.

“This is why the FTSE 250 is in focus. Given the struggles in the debt market, £1 billion-£2 billion is doable for big funds in equity, but so much the better if some of that cash has been brought in by debt at the fund level, replacing debt that would otherwise be raised at the deal level.”

Another advantage of that approach, of course, would be that it avoids lumping the target with more debt – something that could be unpalatable in a capital market that is far less forgiving than during the last 10 years of negligible interest rates.

“The process of rolling over debt is not what it used to be,” said Preston. “Amending and extending just isn’t that easy anymore. If you can bring debt into the fund structure without directly layering it on the target company, you don’t screw up existing lending at the portfolio level. Existing lenders don’t want additional debt on top of theirs, so these techniques are another way of making debt available for deals without treading on any landmines.”

Benoit Duhil de Benaze, a managing director on risk manager Chatham Financial’s private equity team who focuses on hedging and capital markets, had also seen sponsors on some deals go all equity then look to raise debt later in the process, including on real estate deals. But he had not seen them on the very large deals – where a different approach was usually taken.

“On those mega deals, you’d see large investment banks underwrite the financing. But now private debt funds can step up for tickets in €500 million, and some have gone up to €1 billion, so I wouldn’t be surprised if clients on those larger transactions – and we’ve seen this from the inside – would run a dual track processing on the financing, going through banks and private debt to try to get the best terms they can obtain from one or the other.

“We’ve seen a bit less of the very large take-privates, but again, private debt funds are full of dry powder and have an incentive to deploy.”

These techniques are not necessarily new, but are being deployed for different reasons than they might have been over the last few years, according to Duhil de Benaze’s colleague Jackie Bowie, managing partner and head of EMEA at Chatham.

“The fund which holds the equity will have debt, which will be related to the NAV of the fund, using that capital to complete the transaction,” she said. “Once it’s all wrapped up, the asset itself will go and raise debt as an existing acquisition. It’s very easy for the fund to repay and redraw that.

“Two years ago, there was more competition for deals, so if you could commit to getting a deal very quickly, without going to the banking market for debt, there was still a chance you were using a vehicle at the fund level.”

Tech’s appeal

All of the sources spoken to for this article agreed that more take-private deals will surface over the coming weeks and months, not least because the run-up time needed means several could already be in the works.

“The traditional view is that you don’t need to do a lot of diligence on a public company because all relevant information should be in the market anyway,” said Dechert’s Field. “Private equity firms have nevertheless been more robust about demanding access to the underlying data. A PE firm will therefore do some public diligence initially and then approach the target and expect to get access to more detailed diligence. So, these deals won’t have been started recently.”

“The runway is probably a minimum of two months, so back in February or earlier was when these deals were first being contemplated,” he said of the April glut of bids.

The take-privates seen so far this year have ranged across sectors including healthcare, construction, engineering and more. But according to Barr Blanton, chief executive of Crosslake Technologies, a firm which provides due diligence on tech companies, one sector is likely to benefit most from the growing trend for cross-border deals: technology.

“Getting your arms around an international growth strategy is more readily apparent in tech than other types of business – whether services or industrials – where the international component would be more complicated,” he said. “Tech crosses borders pretty quickly. That’s probably an accelerant to the trend.”

But there are still complications when going across borders, including in the tech sector.

“When looking at data security and privacy, you have to look not only globally, but locally as well. It can work both ways – a platform might have to get up to speed on target with a different geographic footprint,” said Blanton. “Those are variables to consider that add complexity, but they also have a known current state. You could spend a lot of time projecting what the future state is going to be, but it’s a known variable to consider.”

Another sign of the increasingly cross-border nature of private equity is the number of US firms setting up European offices, with local knowledge becoming ever more vital in navigating the potential complications that Blanton outlined.

Volatility

Other headwinds – especially for UK targets – could come from the still uncertain picture over rates and FX.

“There’s a lot of activity on hedging,” said Chatham’s Duhil de Benaze. “Usually it’s cross-border, where the sponsor is either European or American or even UK with mainly euro funds. We have very limited clients with sterling denomination. Every time you do a take-private, the takeover code says you must have certainty of funds. The issue is you need to be good for the money in sterling, because you buy the shares in sterling, so any investor will need to find a way to hedge the FX risk.

“You’ll usually see hedging as part of the published documents, because it demonstrates the certainty of funds.”

Sponsors are also increasingly running pre-hedges on interest rates – that are contingent to the deal closing – to protect against rate volatility, Duhil de Benaze added. “We have very often had intraday rates volatility of 10-15bps. If you wait two months and the market moves against you, that could easily be a point higher.”

The interest rate uncertainty was only made worse by the collapse of SVB and takeover of Credit Suisse, said Chatham’s Bowie.

“There was a question of whether that reduction of liquidity and increased cost of credit would impact central banks,” she said. “The Fed is not indicating a turn in that rate cycle, but markets are indicating rates will start to come back down. If you believe central banks are still focused on price stability then there’s no reason why the Bank of England should stop raising rates. There are concerns that central banks will still be increasing rates this year.”

But whether rates stay on their upward trajectory, plateau or even fall, the trend of take-private bids looks unlikely to fall out of fashion any time soon, with private equity firms still sitting on piles of dry powder and ever more financing options available to them.