The notion of a refinancing “wall” in the wake of 2006-2007’s debt-fueled buyout bonanza is not news to anyone. However, with increasing uncertainty in the public capital markets, it is worth revisiting the issue and its implications for middle market M&A. A recent report from KPMG puts the punchline in no uncertain terms saying, “Over $4 trillion of corporate debt matures in the next four years, a legacy of the increasing refinancing requirements of the boom years, leveraged loans in the US and Europe, and the short term funding arrangements made during the global financial crisis. The scale of the refinancing requirement would be challenging at the best of times, but current economic circumstances suggest there are some very difficult negotiations ahead. The options for some companies could be very limited.”
With “covenant-lite” and dividend recap issuances making a comeback in recent months, it was easy to forget about the looming wall of maturities. After all, 2010 was a record year for high yield new issue volume and 2011 is on a similar pace YTD. However, recent volatility in the public markets has sent investors running for safety, and high yields spreads have widened dramatically. In a recent Financial Times article, Mark Sterling, restructuring partner at law firm Allen & Overy, remarked that, “The high yield market was providing much needed refinancing capacity in the face of the refinancing wall. That’s now shut and may not open for a while, given the volatility in the capital markets. This leaves billions of dollars of debt due for refinancing with no obvious source.” Yikes!
With this macro backdrop and the refinancing wall still standing tall, we thought it was worth some thought on the implications of a tightening credit market for middle market M&A participants.
- Larger transactions become increasingly difficult to finance, financial sponsors move down market. Cheap debt fueled many of the large scale transactions (announced) below, and in some cases very difficult lessons were learned. In a tightening credit market these types of transactions would be inherently difficult to finance, but next to impossible with some of these deals (and many more) needing to refinance the debt that made them possible. As a result, don’t be surprised if some of the sponsors behind these deals become more interested in middle market opportunities.
- Companies will increasingly turn to alternative sources of capital. Issuers previously served by the high yield markets will turn to mezzanine financing. Private equity firms themselves are another potential source of capital. With access to an estimated $400 billion in capital according to the KPMG report, and new deals becoming increasingly difficult to execute, creative refinancings or equity cures will become more attractive, or in some cases necessary.
- Companies will seek de-leveraging strategic M&A transactions. By using stock or paying a cash multiple lower than their leverage multiple, corporates can de-lever through strategic acquisition. Additionally, by shuttering assets for multiples greater than their leverage multiple, companies can de-lever through divestitures.
Takeaways for Sellers: The credit quality and reputation of a buyer will be critical. If prospective buyers are highly levered, this will likely impact their approach to valuation. Advisory engagements could be increasingly linked to staple financing packages. Finding the right advisor and buyer for an opportunity is more important than ever.
Takeaways for Buyers: Certainty of close will be an increasingly important factor. Terms of commitment letters are likely to be highly scrutinized. Sellers might be increasingly motivated by financing considerations, and structuring a deal could require some creativity. To quote the exceedingly creative economist Paul Romer, “A crisis is a terrible thing to waste.” There are likely to be very attractive opportunities for those that can bridge the financing gap.