At a glance:
- A well-timed deal can "capitalise on windows of liquidity"
- There was a large drop in deals over the first quarter of 2012, principally because of CLO funds retreating from the market
- The high-yield bond market may fill the gap left by CLOs
- Volatility remains due to the eurozone crisis
The large buyout market in the Benelux, as well as the wider European buyout market, remains constrained as a result of the eurozone crisis, related banking liquidity issues and volatility in collateralised loan obligation (CLO) activity. However, completed transactions in 2011 suggest that if management teams and private equity investors are agile and time deals carefully, they can capitalise on windows of liquidity to complete high-quality transactions.
Still a favoured market
The Benelux is a highly attractive market for European and US investors. Like the UK, its financial and corporate communities have significant experience of the asset class, and benefit from international advisers and lenders with local presence to support private equity in originating and completing transactions.
The Benelux is well known for its large and internationally operating companies with management teams experienced in creating growth opportunities abroad given the limited domestic expansion opportunities – a notable return driver for the larger European buyout houses. Despite pressure in the eurozone, euro-denominated deals also continue to be viewed favourably by dealmakers, given the preference of CLOs for euro-denominated debt.
Liquidity dictates activity
The fact remains that the Benelux private equity market had a slow start to the year – following a relatively stable performance in 2011 compared to rival countries – leaving its near-term outlook unpredictable. The first three months of 2012 saw activity in the region slump to six deals with an aggregate value of €231m, compared to ten transactions totalling €2.2bn for the previous quarter – one of the largest drops in Europe during the period – according to data from Arle Capital.
The statistics illustrate a dearth of deals at the larger end of the market in particular. A major driver for these transactions is the ability to raise debt and, at its root, investment market liquidity in the Benelux and wider European markets, which is volatile at present.
This is largely the result of CLO funds – investment vehicles which buy and repackage bundles of secure, syndicated leveraged loans – retreating from the market, leaving significantly fewer options for banks looking to sell large amounts of debt.
The cost to CLO managers of attracting finance for new funds has increased significantly since the economic downturn. As a result, there are limited new CLO funds coming to market and many are reaching the end of their re-investment period. Therefore, current CLO capacity of approximately €60bn is expected to reduce to around €8bn by 2015.
The cost of funding has also increased for banks as they respond to being required to hold more capital under the incoming Basel III. In turn, many of the smaller players prefer to play arranging roles rather than participating in the deals of others, with the result that the pro rata tranches of facilities are increasingly difficult to sell.
The window of opportunity
For strong companies in the Benelux there are, unquestionably, opportunities to transact. These companies have solid growth track records, defensive business models, excellent cash-conversion and, crucially, experienced and ambitious management teams. They, alongside their private equity backers, stand the best chance of securing favourable debt terms if transactions are timed carefully.
Current active CLOs are dependent on leveraged debt repayments and, as loans get repaid, many are required to reinvest within a limited time frame. In these short periods of liquidity, companies and their backers can secure attractive leveraged debt.
Appetite and competition during these processes between private equity backers, banks and CLOs can be fierce, resulting in favourable debt terms for companies.
The importance of timing the sell down of debt during periods of strong liquidity is exhibited through the uncharacteristically high number of “reverse flexed” facilities seen recently. These structures see arrangers revise margins on loans down following an oversubscription of paper – benefitting the company by reducing the price of debt.
A return to high yield?
Resurgence in the high-yield bond market in Europe suggests that issuances of this kind could play a key role in replacing the gap left by CLOs, as they continue to leave the Benelux and wider European buyout spaces.
High-yield’s flexibility, liquidity and ability to attract investor appetite have seen it emerge as a central feature in the large leveraged buyout funding space in Europe over the last ten years, to an extent replicating the success of this instrument in the US market.
According to Standard & Poor’s Leveraged Commentary and Data for Q1 2012, 32 high-yield bond offerings worth a total of €9.5bn represented approximately double the levels seen in the previous six months in Europe, when 17 bonds were issued for an aggregate €5.5bn.
However, a further crisis in a major European economy could effectively close the high-yield bond market overnight – as it did for parts of last year – and so, while we have confidence in the longer-term drivers for the segment, its near-term uncertainty makes it more volatile than traditional debt markets and cannot be solely relied upon to boost liquidity in the Benelux buyout market.
We envisage the liquidity gap being left by CLOs also being filled by new vehicles, created by or invested in by sovereign wealth and pension funds, while improved stability in the eurozone should further improve corporate performance and deal making conditions.
Quality, not quantity
The large buyout market in the Benelux – and throughout European – remains volatile and a sustained recovery will only be truly realised when continental economic conditions improve. This would have a knock-on effect on corporate performance, investor appetite, confidence amongst sponsors and market liquidity.
Yet despite this uncertainty, deals will be done. These buyouts are reserved for best-of-breed businesses which have propositions with high barriers to entry and management teams with track records of delivering notable expansion against the recent, low growth backdrop – verifying their resilience and long-term prospects.
The Benelux has a host of high-quality businesses with the appetite and attributes to launch buyouts. Provided they can capitalise on relatively short periods of liquidity, we still expect to see a number of sizeable deals involving Dutch, European and US sponsors completing in the region.
Riella Hollander is head of acquisition finance – Benelux and Nordic at Lloyds Bank Wholesale Banking & Markets in Amsterdam.