The outlook for leveraged buyouts has changed fast. A picture is emerging that contrasts starkly to the period 2009 to mid 2022. In a world of free money and an abundance of liquidity, easy debt financing helped valuations run free. Increasing ~80% on an EV/EBITDA basis over the period. But money is no longer free. And this has multiple interlinked implications for LPs, GPs, companies and private debt managers. The circle has become more vicious.
Whilst 2021 deal values and volumes eclipsed the previous 2007 record, 2022 has seen the largest annual drop in 20 years. Albeit back to 2007 levels. But even those impressive levels disguise what happened in 2022. Only in the second half of 2022 did the real slow down begin. Only then did rate rises begin to bite everything a leveraged buyout relies upon to deliver the deal.
Public equity markets did not fare well in 2022, which means that the proxy multiples used to value private companies came under pressure. The fallout of rising rates is a high cost of capital which in turn reduces the net present value of the discounted cashflows. Companies were re-rated downwards from arguably artificially elevated levels, which now turns out to be the hallmark of a period of free money. Deals were done at good levels. But deals were also pulled, as sponsors anchored onto past multiples in the hope that things would return back to the old normal.
As the willingness to sell evaporated, along with the IPO market, the dry powered piled up into the trillions. And as rates continued to rise steeply in the second half of 2022 through to today, the prospect of seeing valuations come back fast has also evaporated. Servicing debt is no longer a single digit interest rate commitment. And pushing price increases through to customers may have reached it's limits. The powder is there. The cashflows are not.
The LBO market has also become a "survival of the largest" market. 2021 saw the average LBO deal cross the $1 billion milestone. With the average loan-to-value currently hovering around 50%, this means facilitating these deals requires access to $500 million. Which brings us back to the problem of exits in 2022. The IPO market was not buoyant and/or the willingness to sell lacking. In other words, the proliferation of private credit managers in the lead upto 2022 has not equated to access and choice. Capacity remains locked up in the deals with no viable exit of the previous period. The number of firms that can facilitate these billion dollar deals today is limited.
Unexpectedly, 2023 has also seen a different dynamic take pole position at banks. Their focus now is maintaining trust and preventing contagion in their ecosystem. Following the failure of Silicon Valley Bank, Signature Bank, and the issues surrounding Credit Suisse, they are busy with deleveraging. Their priority is ensuing their commercial real estate exposure does not lead to instability, and their balance sheets are strong. In short, their loan underwriting willingness has also evaporated.
The larger private credit managers on the other hand, are open and capable of doing big business. They are also quick to highlight that the spread on large LBO deals has widened by a further 150 basis points, to touch 700 basis points today. Factor in the floating foot and this means low double digit yields are on offer to institutional investors. Before jumping in, institutional investors however are doing their math.
If EBITDA is declining, interest expense rising, valuation multiples falling, and exit opportunities muted, leverage is not going to drive investors portfolio IRR. The second half of 2022 has marked a turning point in the types of private equity managers that institutions are engaging. Today's environment requires a hands-on team focused on magnifying revenues, reducing operational efficiencies and extracting greater intrinsic value from the deal. The leveraged buyout is being unleveraged.
The result is that inside RFPnetworks, we still see strong institutional interest in private credit and private equity firms. But in our conversations with them, it is clear that their manager selection processes have definitely become more selective.
