Deal boom on the way, say private debt professionals
July 2018 | FEATURE | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
July 2018 Issue
Buoyed by a strong economy and the free availability of capital, the private debt market may be on the cusp of a deal boom.
2017 saw private debt fundraising and capital deployment surpass pre-crisis highs, according to Preqin, with direct lending funds recording strong growth. Furthermore, private debt funds have been increasingly active; assets under management have increased fourfold over the last decade to $595bn by the end of 2016, and could reach $2.5 trillion in the next 10 years, according to Intertrust.
One of the key drivers of interest in the private debt space is the level of returns generated in the space. Twenty-two percent of investors surveyed by Intertrust in 2017 said that returns from the asset class had exceeded their expectations over the last three years, up from 15 percent in 2016. Only 9 percent thought returns had fallen short.
The lending landscape which changed following the financial crisis has also been a catalyst for the private debt space. Increased regulatory oversight, through measures such as Dodd-Frank and Basel III, saw the private debt market fill gaps left behind, particularly in the middle market. As a result, investors are more eager to participate in the asset class. Thirty-six percent of professional investors intend to increase their allocation to private debt in the next 12 months, according to Intertrust. This increased interest has translated to greater levels of committed capital across the industry, particularly from Asian and European commercial banks and investors. By the close of 2017, private debt fundraising surpassed $100bn in aggregate capital raised by funds closed. And that capital is expected to be deployed over the next 12 months.
According to Proskauer’s April 2018 ‘Trends in Private Credit’ report, more than 40 percent of private debt investment professionals foresee a boom in deal activity in 2018. The majority hold a ‘bullish’ outlook for the future of the industry, with only 12 percent expecting deal activity to decline in the coming year. A key deal driver is expected to be dry powder, cited by 88 percent of respondents. Private debt funds accumulated $107bn in 2017, and more than a third of that capital has not yet been invested, according to Preqin. Other major drivers include sponsors seeking realisations and the state of the US economy. Though it was considered a deal driver by 5 percent of professionals, Brexit is not expected to significantly impact deal activity, though that may change as the March 2019 deadline approaches.
Given the potential of the asset class, the private debt space has attracted new players, including several new hedge fund entrants over the last 12-18 months. The £44.5m M&G Impact Financing fund, for example, has participated in several recent private and illiquid debt deals. Furthermore, in April, Permira Debt Managers signed its seventh direct lending deal, a €150m credit facility which enabled French coffee company Daltys to acquire Maxicoffee.com.
Eighty-eight percent of respondents to Proskauer’s survey expect deal activity to remain the same or increase through 2018, while 41 percent in particular believe it will increase. Companies in the business services, healthcare, software and technology, manufacturing and transport and logistics industries are most likely to be targeted for investment – particularly in the US, where the recently enacted US tax reform is expected to positively impact activity, and was cited as the fourth most important deal driver by investment professionals. Ninety percent of US respondents expect the tax reform to impact deal flow positively or for it to stay the same.
Consumer and retail organisations are likely to suffer, however, as pressure from Amazon and other online suppliers impacts operations and reduces prospects for accessing private debt.
Despite the optimism permeating the industry, however, there will be challenges to overcome. Competition for deals will be one of the biggest issues along with high transaction multiples and a lack of quality assets in the market. Concerns around high multiples are more pronounced in the UK and across Europe.
Potential interest rate rises in the US and UK would also have a bearing on deal activity, though there is some uncertainty about European rate rises. Prices are expected to decline across those jurisdictions where rises occur. The withdrawal of the European Central Bank’s stimulus, expected to occur later this year, will impact credit markets, potentially making it easier for buyers. The impact of the European Leveraged Lending Guidelines, however, is expected to be positive for organisations providing private credit, according to 84 percent of respondents.
Since the financial crisis, the private debt space has been a growth market. Though there may be headwinds in the short to medium term, a deal boom may be on the way, with the US, Canada, the UK and Western Europe poised to be the most targeted markets.
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