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Middle-market private equity pros expect to see a preference for smaller, tuck-in acquisitions of companies instead of bigger, signature platform purchases as the world of mergers and acquisitions eyes a more uncertain dealscape in 2023.
Tighter credit is one reason for this pivot toward buy-and-build strategies for growing companies, along with a gulf between the that price sellers want to get for the companies and what buyers are willing to pay in private markets.
“Private equity firms want the most the market is willing to pay for their trophy assets, so they won’t sell them in this market,” said Graham Weaver, CEO and founder of Alpine Investors, a specialist in software- and services-company deals.
Overall, 2022 brought more uncertainty to private markets amid volatility and weak prices in public equity as the Fed hiked interest rates and as fears of recession climbed.
“The general arc has been public markets get hit, so next the debt markets go risk-off,” Weaver said. “The debt markets have been hit hard, which flows through to what you can pay to buy a company.”
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In 2021, it was typical to see lenders provide leverage of six to seven times earnings before interest, taxes, depreciation and amortization (Ebitda) for acquisitions. Now lenders are typically offering leverage of about four and a half to five times Ebitda.
Meanwhile, capital contributions, or down payments paid by buyers, have climbed, along with interest rates that lenders charge.
Capital contributions now typically amount to 50% of the purchase prices on deals, up from 35% to 40% in 2021, said Michael Ewald, managing director and global head of the private credit group at Bain Capital Credit, a lender to middle-market companies with enterprise values of up to $1 billion.
Last year, the typical interest rate on a middle-market senior loan would have been around 7%. It’s now around 10.5% to 12%.
Bain Capital will likely handle roughly the same number of transactions in 2023 as it did in 2022, but total dollar volume will be flat to down because of fewer M&A opportunities for larger platform deals, Ewald said.
As of June 30, Bain Capital Credit was managing about $41 billion in capital overall.
In a typical year, Bain Credit’s private credit group handles about $2.5 billion in senior loans and about $400 million in junior loans.
With fewer larger deals taking place in the middle market, private equity firms are returning less capital to their investors — also called limited partners (LPs) — just when those LPs need liquidity. LPs have also been less bullish about providing debt capital for deals or investing in new credit funds.
Private equity firms are also finding different ways to get to the altar on deals. Beaten-up stock prices now provide a better entry point for large take-privates for some platform deals, for example.
On Monday, Thoma Bravo won out over Vista Equity Partners for an $8 billion take-private deal for Coupa Software Inc.
COUP,
+26.81%,
and BDT Capital announced plans to buy grill maker Weber Inc.
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at an enterprise value of $3.7 billion.
For its part, Alpine Investors has managed to keep a healthy deal flow because of the strong value proposition it offers to company founders, instead of relying on sales of private equity portfolio companies, Alpine CEO Weaver said.
“We’re seeing a good pipeline of direct founder-owned companies, but not private equity firms selling their trophy assets,” Weaver said.
It could take a year or so for prices to reset to where buyers and sellers are closer on price, he said.
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