RLPC: Pressure to sell spurring mid-market dealflow

NEW YORK Tue Feb 5, 2013 12:40pm EST

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NEW YORK Feb 5 (Reuters) - Increased pressure on middle market private equity sponsors to sell existing portfolio companies is setting the stage for an uptick in M&A-driven activity beginning in the second quarter, sources told Thomson Reuters LPC. Middle market debt providers expect more sponsor-to-sponsor transactions, as well as an increase in growth-oriented acquisitions.

The motivation to sell could be a significant catalyst in ushering in the rise in M&A activity middle market lenders eagerly await following disappointing new money issuance in 2012.

Private equity shops are facing a difficult fundraising environment. In order to successfully raise new buyout funds they must return capital to their limited partners, said middle market debt providers and private equity sponsors alike.

PE funds need to realize returns as a means of demonstrating performance. With a still anemic IPO market, selling provides an alternative exit to show track record while putting capital back into investors' pockets.

"General partners need some exits this year, next year and the following year," said Scott Higbee, partner at Partners Group, a global private markets investment management firm.

While financial sponsors are considering the sale of existing investments, mid-sized companies are increasingly eyeing acquisition strategies as growth opportunities.

According to RBS Citizens' Middle Market M&A Outlook 2013, optimism is high among mid-sized companies with respect to M&A prospects.

"Clearly, top line revenue challenges and low economic growth rates, coupled with historically low interest rates, are leading many companies to see acquisitions as important to their growth strategies," said Bob Rubino, executive vice president and head of Corporate Finance and Capital Markets at RBS Citizens.

Nearly 80 percent of middle market companies active in corporate development are pursuing acquisitions now or are open to making acquisitions in 2013, the report found.

Of those companies, 24 percent are currently involved in the process of making an acquisition. Interest in selling is also significant. Thirty-one percent of middle market firms are open to being fully or partially acquired by an outside investor.

"In addition, private equity firms that postponed selling portfolio companies in 2012 or took advantage of dividend recaps to return capital and buy time, will test the market for exits in 2013," the report said.

NARROWING THE GAP

Pressure to sell, while it is one important trigger, is not the only factor that will dictate dealflow. There must be a narrowing of the valuation gap as well, market participants noted.

Last year, a persistent disconnect between buyers and sellers on price continued to hamstring M&A dealflow. Sponsors and middle market investors expected new money transactions to be greater than what was recorded. A lot of people did a lot of work, but that is not reflected in the volume of deals that cleared the market, noted one financial sponsor.

Lingering economic uncertainties, as well as the looming fiscal cliff, budget concerns and the impending rise in tax rates also contributed to the impasse. In a rush to beat the tax changes a barrage of deals were pulled forward, driving home record dividend recapitalization volume in 4Q12. The tax issue, however, did not trigger meaningful M&A activity as some had hoped.

Buyers are comfortable paying a premium when they have visibility on company performance and the general economic conditions, said Ted Koenig, president and CEO of Monroe Capital, a middle market debt provider.

"The biggest impediment to the most aggressive and efficient purchase price multiples is the lack of visibility on future revenues and macro-economic stability. It's a buyer issue," he added.

According to the RBS report, 41 percent of current or potential sellers said their top concern is being underpaid or undervalued, especially among smaller firms with between $5 million and $25 million in annual revenue. At the same time, more than 50 percent of mid-market executives also believe prices will remain stable, and more than 33 percent see prices increasing.

"There are a number of forces that will bring bid-ask spreads closer together for both parties. People will be more realistic about the valuation of a business in the marketplace," said Higbee.

One regional banker, noting more traction and dialogue with public companies, expects to see greater "asset trading." As corporates continue to streamline operations in a low growth environment, increased corporate spinoffs could generate more corporate to corporate activity or corporate to financial sponsor transactions, the banker noted.

For example, ATI Physical Therapy tapped for a $305 million credit facility to fund GTCR's sale of its stake to KRG Capital Partners. The deal was upsized from $285 million and the Libor spread was cut by 50bp to LIB+450 on strong demand for the paper, sources said.

Likewise, LMI Aerospace Inc, a public company, is raising a $350 million credit backing its acquisition of privately held Valent Aerostructures. The revolver was upsized and institutional pricing tightened in response to lender appetite.

For middle market companies, expanding market share and growing existing platforms through add-on or tuck-in acquisitions presents an attractive play. When the new money deals come, there is no doubt yield starved investors with money to spend will be equally game to pile in.

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