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Private Credit 

Shubham Saharan

This article is part of our new service, 9fin Private Credit, which will soon require a separate subscription to view. For more info on this product and the accompanying database, contact subscriptions@9fin.com

This year was a bit of a washout for M&A, so market participants — whether that’s bankers, sponsors, lenders or LPs — are pinning their hopes on a big 2024. Will it deliver?

In the third quarter of 2023 alone, the total deal value of domestic US private equity activity dipped below $200bn for the first time since early 2020, when the pandemic shut markets worldwide, according to PitchBook.

By extension, private credit has suffered from a slowdown in new deal origination volumes, and many lenders have been relying on add-ons to plug the gap. 

Hope springs eternal among M&A bankers, and sometimes it feels like the big wave of dealmaking is perpetually just around the corner. This dynamic is exactly what happened in late summer, when a flurry of activity around Labor Daygot people excited only for disappointment to set in a few weeks later. 

Will the first months of 2024 be any different? Here are three good reasons to think so:

Disputes over valuation were one of the biggest obstacles to successful M&A in 2023. Elevated interest rates were another. 

Heading into 2024, the Fed’s recent messaging around potential rate cuts has given a boost to equities and provided some visibility over the rate outlook — and moreover, market participants have become accustomed to the new normal. 

“We’re hopeful that with stability in rates and valuations, especially following two years of seasoning and these valuations, it’s easier for public companies to consider transacting,” said Logan Nicholson, a managing director in Blue Owl’s direct lending team. 

Also, sponsors can only stay out of the market so long. The pressure for private equity firms to return capital LPs or deal with upcoming debt maturities at portfolio companies creates a lot of pressure for deals to get done. 

“Every day that passes with over a trillion dollars in private equity money on the sideline, only creates more pressure,” said Doug Cannaliato, co-head of origination at Antares. 

“Being in this business for over 25 years, I’ve learned never to underestimate the power of that dry powder, as history shows it will get put to work. It’s just a matter of time,” he said. “LPs continue to put pressure on private equity firms as they've done a number of secondary trades at less than par and they're not interested in doing this forever.”

There’s also pressure among direct lenders to put dry powder to work. We’ve covered a couple of secondary sales of LP stakes in private credit funds recently (Neuberger Berman and Brightwood Capital Advisors), but just like in private equity, LPs aren’t interested in doing this forever. 

As we’ve covered previously (here’s the link again), the hopeful M&A processes that fizzled out after Labor Day were no fun for anyone involved. 

We’ve reported on a few: Medtronic, Gables Engineering, FDH Aero. But from what sources tell us these stories are just the tip of the iceberg. There are a lot more companies out there that tried to sell themselves and failed, which means a lot of diligence has been done.

Some of these processes led to incomplete outcomes (Health & Safety Institute got a new minority investor, PEI Group got transferred to a new fund by its existing sponsor) but the ones that were left completely undone could quickly come back to market and resume talks with bidders.

Some of them already have: KKR’s bid for Cotiviti is a good example. That deal isn’t fully signed up yet, as far as we know, but some others are: Shearers’ Foods, for example, has signed a deal to be acquired by CD&R. 

One caveat, which is shown by both these deals, is that private credit doesn’t have the same competitive advantage to win these financing mandates as it did for much of 2023. 

Last week, we wrote about how the recent rally in credit has put banks in a better position to lead the Cotivitifinancing, and the Shearer’s Foods deal features a structure that became fairly routine for new LBOs before the 2020 pandemic: a syndicated first lien, and a private credit second lien.

Maybe there’s space for these old-school structures to come back in 2024, and the banks and the direct lenders can share the spoils of a recovery in M&A. 

In the last few weeks, there’s been a flurry of new CLO issuance. At least six managers aimed to reset legacy CLOs, and others looked to entirely new deals. That bodes well for demand in the BSL market, which in turn bodes well for debt-funded M&A.

But researchers are split as to what the CLO market will look like next year, with some questioning whether expected spread tightening will be enough to support a reset wave that will could push out the CLO market’s reinvestment wall.

That reinvestment wall has caused problems lately. Amneal Pharma, for example, had to sweeten some terms in its recent refinancing deal after some CLO managers that held its existing debt were hamstrung by post-reinvestment restrictions. 

There are some ways around the reinvestment crunch (we documented them here) but it’s an undeniable headwind. If those headwinds ease, that probably adds to the bull case for M&A; but if they don’t, that doesn’t necessarily stop M&A activity from recovering. 

Either way, the uncertainty around the reinvestment issue plays right into the hands of direct lenders, at least in terms of their pitch to sponsors. 

“What I don't think is fully appreciated is how that [the CLO reinvestment problem] can impact the liquidity risk in the public markets,” said Milwood Hobbs Jr, head of sourcing and origination at Oaktree. “What I've been telling folks is sponsors really want certainty of execution, and private credit, for better or worse, provides that certainty.”

Then again, plenty of BSL names have migrated to the private credit market recently. CLO managers might not be too upset to see some of these troubled names disappear from their portfolios (Greenway Health, Electro Rent, CPP), but they still need to reinvest that cash. 

There are a lot of moving parts here. But basically there’s a lot of cash out there looking for a home, and a lot of it has been waiting to be deployed for far too long.

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Private credit 2024 outlook — Part 4 The M&A force awakens

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