Debtwire – Banks, Private Equity Firms Prepare For Potential Down Cycle (November 28, 2018)

As warning bells signaling an economic contraction ring louder, private equity and lending firms are starting to take steps to safeguard their portfolios, several industry sources said.

While the M&A pipeline continues to grow with multiples reaching record highs, the prior ‘any deal can get done’ mentality is waning with transactions in cyclical sectors starting to struggle, the sources noted. The pushback is emerging not only in the form of private equity firms increasing their selectiveness, but also from banks that are no longer willing to write checks at exceedingly high leverage levels, they said.

“Lenders are being appropriately cautious with leverage levels in cyclical end markets that are at historical highs,” Christopher McMahon, Baird’s Head of Global M&A said.

Among the more volatile sectors feeling the impact of tightening purse strings is the building products space, one banker said. Bidders are beginning to hold back in offering high multiples due to increased expectations that companies in the space will miss their projected financial results amid a lag in product demand and added competition, the banker noted. Despite deals moving forward, valuation expectations are trending lower, the source said.

Wolf Home Products, a distributor of kitchen and bath cabinetry, which progressed to the second round of its auction in early September, recently put its process on hold after it failed to attract a targeted 9.5x- 10.5x valuation. The company went up for sale in the early summer, with bank Fidus Partners marketing the firm in the mid-to-high USD 20m EBITDA range.

On the private equity side, firms are shifting portfolios to less recession prone sectors, the sources continued. One private equity investor said that his firm is buying food companies, industrial technology firms, pet food companies and medical supplies firms as they view those as better protected during an economic downturn.

Potential private equity bidders are also raising questions about the recession case for a company during its marketing process, Marc Cooper, Chief Executive Officer of PJ SOLOMON said.

The sponsors in some ways are behaving like strategics, making several add-on acquisitions to strengthen the existing portfolio and increase a firm’s overall value, the sources noted. One private equity source said they were in discussions to close 13 add-on acquisitions by the end of the year and not looking at major platform acquisitions as valuations are extremely high.

“They love the concept (of add-on acquisitions) because it’s a way for them to create synergies and fundamentally reduce their original purchase price,” Cooper noted.

Big Tex Trailers, a Bain Capital-owned company acquired from HIG Capital in 2015, when it generated around USD 50m in annual EBITDA, is now generating around USD 200m in annual EBITDA. Under the new ownership the company has made several acquisitions and merged with fellow Bain portfolio company American Trailer Works in 2016. Bain Capital is now exploring a potential sale of the firm with Goldman Sachs and Morgan Stanley as the private equity firm seeks to take advantage of the positive conditions.

It’s a good time to sell, especially if it’s a good business, the only issue is with the buying as multiples for good performers are high, one banker said. Selling a business now will free up capital for investors to back potential acquisitions at more reasonable valuations during a downturn, one private equity investor said.

“People are big sellers today for two reasons: one prices are great and second is that they feel that we are in the late stages of the economic cycle,” Cooper went on.

Investors who would typically like to bid in the 4x-5x range are putting in bids in the 7x range, so these buyers are salivating for a correction to go back to those times, one private equity source said. There are sponsors that wait for market corrections, the only difference now is that the market experiencing a prolonged bull market so not many have been able to stay on the sidelines, a second private equity source noted.