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Josie Shillito

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A new public-to-private this week (HIG Capital’s £315m take private of UK-listed courier and logistics company DX Group, announced 17 November 2023) serves up a firm reminder that public markets continue to offer value to sponsors in an otherwise opaque and lumpy M&A environment.

However, the debt financing backing the acquisition does not. DX Group’s financing, provided by international bank Nomura and US asset manager PGIM, leveraged at only 3.5x but priced at a rewarding (to the lenders) 700bps on the senior debt, will cost DX Group as much as 12.25% all-in when base rates are taken into consideration. Yet it is not as if sponsor HIG Capital has much choice.

“You’ve got to remember that in the UK there’s the ‘rule of six’ in the takeover code,” said a market source familiar with P2Ps, referring to the UK Takeover Panel’s rule that no more than six parties are to be informed of a planned acquisition ahead of the Rule 2.7 announcement. 

“Traditional banks may be interested in this kind of deal at this kind of leverage, but they would still need to club together to make £150m,” said a second source, “which does not suit the rule of six. Private credit, on the other hand, can write larger tickets.”

It is this reticence to commit to large tickets or underwrites that allows private credit to win out again and again. Particularly in P2Ps where small groups, agility and secrecy are paramount. In 2023, these have boasted private credit in their debt, whether it be advisory services firm, K3 Capital, smart metering services provider Sureserve, clinical researcher Ergomed, veterinary pharmaceutical product manufacturer Dechra, conference organiser Hyve,alternative asset manager Gresham House, or legal services provider DWF. 

The only sponsor-led P2P without private credit financing this year was Apollo’s take private of The Restaurant Group— and in that case, the bank financing package (£260m senior term loan and a £75m revolving credit facility from RBC and ACMP Holdings) is only a bridge loan, to be refinanced in one year into — perhaps — private credit. 

As an enterprise value story, P2Ps make a lot of sense. “With private equity sponsors sitting on record levels of capital commitments, the fall in public company equity values presents an opportunity for sponsors to deploy some of this capital,” commentators such as law firm Debevoise and Plimpton were saying as long ago as 2019. 

Calculated off of structuring EBITDA of £43.6m, DX Group’s enterprise value leveraged at 7.2x — a bargain if compared with debt packages in tech, healthcare or insurance sectors that command a seven-handle leverage figure on the debt alone, with enterprise values nudging 14-16x. Proposed debt packages for IRIS Software’s planned LBO have been close to this level, with enterprise values reaching 14x. 

Additionally, the private debt package, although high margin in comparison with a traditional bank, is no outlier in private credit terms.

Looking at 9fin’s Q3 2023 middle market (companies of €5-50m EBITDA) leverage average of 3.4x, the DX Group’s financing only sits one decimal point over this. And, although 700bps is at the higher end of pricing, the sector, size (£150m) and sterling currency will have provided price support. 

Nonetheless, achieving a debt package of 3.5x without requiring much more than a 50% equity cheque on the part of the sponsor represents value. 

It also shows that traditional banks are by no means making a comeback in public-to-privates. Despite leverage of 3.5x, (an arena in which banks could start to compete), the £150m debt package is very much a private credit financing in both pricing and in the shape of its term sheet. 

Nomura took 50% of DX Group’s debt package (comprising a £110m senior secured term loan facility priced at SONIA + 700bps, a £10m credit acquisition facility, also priced at S+ 700bps and a £20m bridge facility — pricing TBC), with US asset manager PGIM taking the rest.

The terms comprise a leverage covenant, set at 3.5x for two years, after which it will require step downs of 0.25x per year until it reaches 3.0x. The most-favoured nation (MFN) clause is set at 18 months. So far, so conservative. So why wouldn’t a traditional bank be interested? Why is the sponsor left paying as much as 12.25% when base rates are taken into account on a conservative, low-leveraged debt package?

“There still isn’t the appetite amongst traditional banks — by that we mean those that would take small tickets, club together and offer five handle pricing, for a large single underwrite,” pointed out the second source.

Nomura, on the other hand, would be classed as a bank doing private credit in this deal. In this “grey area” (words of the first source) are also banks like Investec and at the larger end, banks doing private credit like Goldman Sachs and JP Morgan.

A recent piece of research from business administration outsourcer, CSC, has found that more than half of GPs (55%) expect on-demand or daily portfolio performance reporting to become normal over the next three years — a terrifying prospect considering some GPs with substantial assets under management still have one or two people teams responsible for reporting.

At the same time, GPs are already preoccupied with creating more and more complex fund structures to achieve diversity. “Fund structures will become more complex to achieve what is expected [in terms of diversified investment],” says the report. 

“We believe, and the data supports, that there will be increased use of special purpose vehicles (SPVs), hybrid funds, and credit facilities to achieve diversification.” 

“But private capital leaders naturally worry about how they will manage this activity with legacy technology stacks and a talent crisis.”

Most GPs responded that the best approach was to invest in technology. That was followed by expanding in-house teams, investing in distributed ledger functionality, and outsourcing more functions.

However, as the numerous private credit managers have pointed out, outsourcing is not always a quick option. As 9fin reported, creating and maintaining numerous different vehicles within one asset manager — be they wrappers, or separately managed accounts to support co-investments from LPs — is cost-intensive from a regulatory and legal perspective. 

This agility, ironically, comes from years of investment in the back office. This internal plumbing cannot so easily be replicated in newer fund managers, and it can’t be outsourced, 9fin sources had insisted.

Yet for CSC, outsourcing solutions can succeed, depending on the size of the fund. 

“For many emerging and mid-market managers, completely outsourcing their back office can be an efficient and scalable solution,” David Sarfas, co-head of fund solutions at CSC, told 9fin. However, he added: “Larger managers may require a customised model, i.e., co-sourcing, to strengthen their back office with the expertise and around-the-clock support needed to meet these reporting goals.” 

Regardless of the outsourcing model that best fits a particular manager, demand for better reporting and more sophisticated infrastructure looks set to rise in the private capital markets.

LBO processes have been following longer timelines, with private credit funds often waiting a couple of weeks after first bid deadlines to understand which sponsors are through. 

“We’re still waiting,” communicated one private credit fund manager.

Some blame the valuation gap for the delays, others put it down to strategy: pursue a long first round bids period to lock in valuations then a short second round bid. Blackstone and Permira’s take private of online advertiser Adevinta, which has spent several weeks now locked in valuation issues, is an illustration of this issue.

Nonetheless, hefty deals continue to come to market, such as the sale of German metering business Techem, backed by as much as €3bn debt, as well as more special situations, such as German jewellery chain Amor, following a restructuring of the company’s debt pile two years ago. 9fin clients can click here for the full named and detailed list of details, or subscribe to 9fin Private Credit by emailing subscriptions@9fin.com.

Taking the Credit — P2Ps continue to please

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