PE deals slump amid volatile markets

Tough financing markets and market turbulence are causing sellers to shelve deals mid-auction or postpone sales, drying up private equity dealmaking with little hope of recovery any time soon.

In recent weeks, French retail group PPR postponed the sale of its catalogue business Redcats, and industrial company Schneider Electric SA has delayed the roughly $1.4 billion sale of US subsidiary Custom Sensors & Technologies, according to people familiar with the matter.

“For private equity firms, debt levels are definitely coming in and rates are going up, which makes the financing more expensive,” said Jeff Raich, managing director and co-founding partner of investment bank Moelis & Co. “This should limit the ability to pay.”

[caption id=“attachment_90660” align=“alignleft” width=“380” caption=“Volatile stock prices also make it harder for two sides to agree on value. Reuters”]  [/caption]

Private equity-backed deal volume in the third quarter was down nearly 30 percent to $53.1 billion from the same period of last year, according to Thomson Reuters data through September 22. That is also 22 percent lower compared to the previous quarter.

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So far in 2011, however, such deals are still up about 14 percent from a year ago to $175.2 billion, Thomson Reuters data shows.

Financing still remains relatively cheap for companies with strong credit ratings. But private equity deals typically need leveraged loans and high-yield bonds - the riskier form of lending that carries some of the highest interest rates and often is among the first financing to be withdrawn when credit tightens.

When banks commit to deal financing in a volatile market, they often put in place a lot of “flex,” which gives lenders the ability to raise a loan’s interest rate as long as it stays within a range agreed upon between the bank and the borrower.

“It’s more week-to-week in the high-yield bond market and that does create for private equity firms’ difficulties in valuing companies because the interest rate and the amount of debt available to finance an acquisition could move within short periods of time,” said Christopher Ventresca, co-head of North American M&A for JPMorgan.

“They have to feel comfortable that the permanent capital structure is the one they have modeled and assessed in light of the price they are paying,” Ventresca said. “It does make it harder to put those deals together during volatile times.”

Spreads on debt that tightened in the spring widened over the summer, making debt much more costly and making it almost impossible for private equity firms to fund deals that meet their return expectations.

Markets that have been spooked by concerns in the euro zone have been struggling to price 11.5 billion-euro European debt on deals done before the summer, according to Thomson Reuters LPC data, leaving underwriters facing potential losses.

“Nobody is going to underwrite anything today that is meaningful in size because you don’t know what the market is that you are underwriting into,” said Karen Simon, global co-head of financial sponsor coverage at JPMorgan.

Volatile stock prices also make it harder for two sides to agree on value.

One bright spot is that there is abundant capital available for deals in the United States and Europe, which should translate into more deals once stock markets and financing conditions turn more favourable.

“For high-quality assets, there is a very strong bid in the market because there is a significant amount of capital to be deployed by private equity firms,” Moelis’ Raich said.

Reuters