For sponsors, three key things will be important…

Creativity

Now, sponsors are required to be more creative in their structuring and pursuing of deals. Including looking at more structured investment opportunities such as preferred equity, which can provide some downside protection, or exploring innovative financing structures such as fund level NAV debt facilities, to use leverage at the fund level to increase fire power / liquidity.

Businesses that were heavily impacted have accessed emergency funding, markets have recalibrated, and primary activity levels have been improving – all building momentum.

Redressing the balance

Re-establishing the balance from portfolio management to looking at new deals / deploying NEW capital will be increasingly important for sponsors. Recent changes in the lockdown restrictions have facilitated management team introductions, catalysing some of this change. We are now starting to see more momentum in deal flow in the near term, allowing funds to complete deals with more conviction.

Navigating the new landscape

The competitive landscape for deals has certainly changed -  with EBITDA valuations, on-going impact of Covid-19, threat of further lockdowns, and, significantly, the repercussions of a broader economic downturn, all contributing to disconnect between sellers’ aspirations, and buyers’ pricing.

Nevertheless, with dry powder amongst sponsors strong and fundraising continuing for many successfully through lockdown, demand for high quality, resilient businesses are at an all-time high - and these businesses continue to trade at premium valuations. We continue to track these resilient assets closely, pre and post lockdown, across all sectors and are encouraged by the quantity. For other more complex M&A deals, it is likely that processes will either elongate, stall or progress in smaller more focused bi-lateral processes.

For lenders…

Credit investor demand for scale and resilience

Recent transactions in the large cap loan market demonstrate the willingness of credit investors to deploy capital to resilient businesses, with credit funds sitting on significant dry powder.  Ardonagh, the insurance broker, for example has recently secured what is believed to be the largest unitranche yet, at c. £1.6bn, a testament to the depth of capacity available within the direct lending market and its credibility as an alternative pool of liquidity to the capital markets. Equally, the successful syndication of TKE shows the depth of capacity in the syndicated market is for a rated, liquid issuer, giving confidence to underwriters and investors. Whilst these are large cap deals, mid-market investors are equally prioritising resilience over return.

Focus may shift

Primary loan market activity has been led on the liquid side by a strong CLO bid, and on the illiquid side by the depth of dry powder seeking deployment in a low volume market. Credit investors will continue to proceed with caution, and will equally have an eye to an anticipated second wave of Covid related covenant amendment activity expected, with Q2 compliance certificates due imminently. As lenders temporarily shift focus back towards existing portfolios, new business activity may pause with processes and approvals taking longer.

Optimism can return

Although the return to a ‘normal’ pre-Covid market environment (with consistent flow of M&A and supply of credit) is still further afield, with a number of headwinds outlined above, there is growing optimism across both markets that the momentum witnessed in recent weeks will continue into the second half of the year.

UK Highlights

  • Sponsors and borrowers are keen to progress transactions and make as much progress as possible during this current period of relative calm
  • Lenders remain keen to look at new investment opportunities, particularly direct lenders with significant dry powder to deploy. Balancing resources across the existing portfolio and new business has, however, led to lenders needing greater buy-in internally - and transaction certainty - to commit resources to a new business opportunity
  • Despite the appetite to look at new business and deploy capital, lenders remain disciplined on achieving optimal yields and focusing on the strategies that can deliver this, for example some direct capital captured the short opportunity to deploy in the liquid market during the early April market dislocation
  • Staying alert will be key! Businesses should continue to pay close attention to forecasting and cash flow requirements, particularly as many costs and payments will be ramping up and certain Covid-19 support measures unwinding, no doubt prompting difficult discussions between lenders and shareholders
  • Sponsors need to carefully consider the timing of new processes, and businesses need to approach lenders in a timely manner as committee processes are taking longer. A second wave or lockdown cannot be ruled out and would add extra time as lenders work through an increase in amendment and liquidity requests

France Highlights

  • Both lenders and sponsors are focusing simultaneously on portfolio management and new investment opportunities
  • On the one hand, most of the portfolio companies impacted by the lockdown have secured a state loan to avoid any liquidity tension, and now need to amend – if not already done – their documentation with their lenders
  • On the other hand, given the high level of liquidity in the equity and debt markets, both sponsors and lenders are looking at opportunities to invest in ‘Covid-proof’ assets, for which valuation multiples remain strong, and promising investments
  • We are seeing a sharp rebound of activity among the financial sponsors, with numerous transactions hopefully ‘in the making’ before the summer break. Some M&A processes have been pushed back to September, and Q4 is expected to be quite active
  • From a lending perspective, both private debt funds and banks are supporting sponsors in auction processes, with a specific attention on the resilience of the business in case of a new potential lockdown
  • Refinancing processes have been less common. Due to recent market conditions, re-financings could have been costly and lenders were less eager to finance a dividend recap
  • We would recommend monitoring cash levels as much as possible to avoid any liquidity tension going forward
  • If needed, asking lenders to renegotiate legal documentation (covenants, baskets, etc.) based on a downside case
  • For businesses that have proven resilience during the pandemic by meeting or exceeding pre-Covid budgets, we would recommend monitoring opportunistic refinancing options

Germany Highlights

  • Interaction between sponsors and advisors has increased due to an almost ‘back to normal’ travel environment, and a more optimistic view on the future economic situation in Germany
  • Subsequently, the focus is now not only on potential carve out situations coming from corporates or potential distressed companies within a PE portfolio, but also the right timing to prepare for exits in a post Covid-19 scenario
  • Some sponsors have managed to extend their mandates – making them more flexible and able to access a broader range of opportunities, such as minority vs. majority, leverage levels, debt instruments and equity linked instruments   
  • On the lending front, a recovery of liquidity with corresponding lower spreads could be seen in the market during the past weeks. Equally, increased activity in LBO and high yield markets has occurred, driven by the backlog of pre-Covid-19 transactions, which were put on-hold during the crisis
  • The focus for lenders is still on refinancing and securing liquidity, however, the number of new deals is growing. In light of Covid-19, the sector the company operates in seems to be somewhat more important than credit metrics on certain transactions
  • Since the start of the pandemic, liquidity programme KfW has received 75,451 loan applications totalling more than EUR 51bn
  • Despite a recovering economy, we expect an increased number of restructurings to surface in the coming months in certain sectors. Those which were hardest hit by the pandemic and (additionally) face structural headwind that intensified during Covid-19 may still struggle (e.g. retail, automotive & aerospace businesses)
  • For the more resilient sectors such as healthcare and software, we will likely see a number of M&A transactions launched in the coming weeks. The majority of deals across other sectors will come in Q1/Q2 2021
  • Bank lending remains overall more restrictive as NPL on balance have increased and guarantees/liquidity lines have been drawn which means funding is more likely to be provided by debt funds. On smaller PE deals, a higher share of all-equity LBO transactions remain persistent
  • As the market prices still contain Covid-19 premiums despite recent reductions, the cheapest deal is currently not possible. However, given the small number of deals in the market, the awareness of each transaction in the financial community is high. Therefore, prudent investors still continue to be open to new business
  • We recommend clients are well prepared ahead of lender discussions ensuring comprehensive information regarding the impact of Covid-19 can be presented – particularly on their operations. Banks continue to carefully evaluate shocks or situations like the Covid-19 pandemic in their credit assessments

Spain Highlights

  • Despite the unexpected crisis caused by the Covid-19 pandemic, private equity funds in Spain have reacted quickly to strengthen their portfolio companies and are actively analysing opportunities, especially in resilient and strong sectors like technology & software, healthcare and food
  • Some M&A projects that were muted on the lockdown have been recently resumed and successfully closed, showing the strong appetite and limited investment options
  • Though assessing the impact on businesses is proving challenging, as it is currently masked by the government support schemes and liquidity (e.g. ICO program), the M&A industry will experience a rebound in corporate operations towards the end of 2020 into early 2021, once the impact of the pandemic can be evaluated
  • New build-up opportunities will arise and private equity portfolio companies will have the opportunity to acquire smaller businesses to reduce competition, become stronger and grow, resulting in an eventual consolidation of sectors that are currently fragmented
  • Deals will be more complex and structured, and buyers may have more bargaining power than before lockdown. As Government’s support schemes end and capital structures become progressively overleveraged, we expect banks to be less supportive. Subsequently, we expect debt funds and minority equity deals to play a relevant role in the mid-term
  • In the lending market, most of the ICO deals have been structured with an amortizing scheme, including a one-year grace period, so we expect refinancing deals to sharply increase in 4Q20/1Q21 as maturities draw near and debt servicing increases
  • We will also see more distressed and restructuring deals in sectors heavily affected by the pandemic, and therefore greater activity of funds focused on this market segment
  • While fund raising is not expected to be affected (as interest rates keep low and private equity is a suitable alternative for investors), private equity and debt funds are looking for bilateral opportunities to deploy dry powder without the competition of auction processes
  • Given the challenging outlook, Spanish businesses should:
    • Prepare cash forecasts under different scenarios, including very conservative cases and stressed scenarios
    • Ensure shareholders consider not only debt solutions but equity alternatives to recapitalize companies and preserve the long-term value
    • In case a refinancing is potentially required in the mid-term, prepare in advance, anticipate the process and approach lenders when there are still no cash constraints

Italy Highlights

  • Despite some positive signals, liquidity remains an issue for SMEs, with the possibility of accessing emergency funding essential for recovery and / or survival
  • The most important instruments remain government-sponsored financings, mainly Sace-guaranteed loans. Though Italy remains a bank-centric economy, private capital is growing, and some are advocating the introduction of Sace-like instruments into the private capital arena
  • Government intervention in the economy is due to increase after the agreement reached on the Recovery Fund by European leaders, which will grant around €80 billion non-repayable funding and c. €120 billion loans to the Italian executive
  • Uncertainty remains a key issue for banks in the medium term. Though Italian banks have continued to pursue their deleveraging in 2020, the post-pandemic crisis might bring about a new wave of non-performing exposures
  • Bid-ask spread on assets remains somehow high, with sellers unwilling to cut deals at lower than pre-Covid conditions, and sponsors cautious about paying full multiples on pre-Covid or normalized results
  • This gap has created room for creative solutions, with deals predicated upon two price components: a spot one, based on post-Covid ‘depressed’ results; and an earn-out based on achievement of pre-Covid results
  • Although cyclical, retail and heavy industrial businesses remain the more impacted, both in terms of potential interest and expected valuation. We have seen some players starting to focus their attention on those with significant competitive advantage, in search of good targets at more reasonable prices
  • Demand for healthcare, food & beverage and software assets continues to be strong, paving the way for a gap widening in multiples between resilient businesses and sectors that may be deemed less resilient
  • Sponsors have started to refocus their efforts on pipeline and 3-4Q potential exits. Liquidity is abundant and the need to deploy capital has reached a peak in recent weeks
  • The economic shock has polarized the performance of Italian corporates, especially SMEs: the more solid and structured have already shown signs of recovery, and have even improved their competitive positioning; while companies that already had weaker competitiveness have become more fragile and many seem to be destined to disappear, or to be acquired in a distressed fashion
  • In such context, strategic buyers are in search for assets which are currently under-performing and can be acquired at favourable terms, while financial investors seek to exploit consolidation opportunities in highly fragmented sectors (e.g. food service, fashion suppliers, technology)

As ever, we are here to advise our clients in all types of market scenarios. Our Debt Advisory & Restructuring practice provides a full suite of balance sheet solutions, including advice on short-term liquidity, amendments, refinancings, covenant waivers and resets and restructurings. With access to the full range of capital providers we are abreast of the developments in the loan market and in particular, the impact from Covid-19.

Please do feel free to reach out to the team via the details below - we would be delighted to discuss any market or specific questions you may have.