* Public to private deal shows underwriting risk improving
* Valuation gaps still seen as the biggest hurdle
* Debt market liquidity supportive for deals
By Natalie Harrison
LONDON, Oct 26 (IFR) - Tentative signs are emerging that the impasse in European leveraged buyout activity may be easing, but the absence of major deals for the past few months will make it tough to establish fair value, leveraged finance bankers say.
Private equity firm Advent struck a deal to take over control of German retailer Douglas this month, in an example of a public to private transaction that are usually regarded as bullish indicators for M&A.
"Inherently there is a lot more risk in both the structure and the financing involved in a public to private deal," said one leveraged finance banker.
"The gestation period is certainly longer, so when you sign up for the financing commitment, it's uncertain how long it might take and whether shareholders will take up the offer. It shows risk appetite among banks to underwrite has improved."
Looking ahead, first round bids for French laboratory group Labco, in which private equity group 3i is a majority shareholder, are due some time during the first two weeks in November.
TeliaSonera is also expected to kick off the sale process for its Spanish mobile operator Yoigo in the next two weeks, which could fetch up to EUR1bn.
Banking sources said that two staple financings have been provided for the sale of two Nordic companies, but it was not clear whether this was for the TeliaSonera asset sale.
"Things are picking up a bit. We could be looking for some deals to complete by the end of the fourth quarter, although it could end being first quarter business," another banking source said.
But two potential deals hit the buffers just this week.
Norwegian IT company Atea ended talks with private equity firm Bain this week, while BC Partners cancelled the sale of German SGB Starkstrom, Reuters reported.
Disagreement over valuation - a row that has led to a gridlock in LBO activity over the last six months - was not a factor in the former situation, which would have included around EUR600-700m-worth of debt, according to market sources.
However, valuation was a bigger problem in the Starkstrom case, leaving just one bidder in the process that was ultimately held back from pursuing the deal by Chinese authorities, Reuters reported.
LBO volumes in Europe fell to USD4.64bn in the third quarter - the lowest since the first quarter of 2010 - Thomson Reuters Loan Pricing Corp data shows, with only five deals worth over EUR1bn completed this year compared to 11 in 2011.
The slump in LBO volumes this year means bankers are cautious, especially as the sheer lack of deals means there are few benchmarks to help establish valuations.
The Douglas deal is positive, but one swallow does not make a summer.
"It is very difficult to establish what fair value is because there are just not enough businesses up for sale to make comparables," said another leveraged finance banker.
"Firms don't want to buy everything, they want to shop around in different sectors."
The banker pointed to much stronger activity in the U.S. where LBO volumes reached USD27.8bn in the first three quarters, with the last three months the busiest of the year, RLPC data shows.
A large part of the problem for deal making in Europe remains the uncertain eurozone sovereign debt backdrop.
"Buyers are saying that for European companies there is the overhang of Europe, and that uncertainty requires them to insert a valuation discount to fair value to protect themselves," the banker said.
At the same time, sellers want the best price for their assets, especially if they have spent time and money turning the business around over the past five years - and they are not forced sellers.
The situation is not completely dire, especially from a financing aspect.
Private equity firms are increasingly taking advantage of the deep liquidity in debt markets with global annual high-yield volumes likely to smash 2010's record volumes of USD322.9bn.
The strength of capital markets, and the cheap financing available, should at least support leverage multiples and make it easier to do larger LBOs. Conditions are also ripe for more aggressive dividend deals - an alternative to sales or IPOs.
In the meantime, privately owned business, which were victims of failed auctions earlier this year, are now seeking dividend recapitalisations.
Permira, at the centre of the most high-profile failed auction this year, is now raising a loan for its frozen food business Iglo to fund a shareholder payout, RLPC reports.
Issuers are also seeking greater flexibility.
Grohe, best-known for its bathroom fixtures, this month issued a floating rate note with a short one-year call feature that would make it easier, and cheaper, for private equity owners TPG and Credit Suisse Private Equity, to exit.
Elsewhere, Luxembourg-based Dematic, a supplier of logistics and materials handling solution, issued a USD275m PIK toggle which stood out for two main reasons.
Not only did it have a short one-year call feature, but it also included an unusual provision allowing the issuer to call the bond at a price of 101 - as opposed to a more expensive make-whole provision - for the first four months if the business is sold in the first two months.
Private equity owner Triton is looking to sell Dematic for EUR700-800m, but if that fails, it has still been able to monetarise value in the asset.
"Not only were investors willing to finance a dividend, but they also more or less waived a right to be taken out at a much higher level over the next four months," said one of the bankers.
"It's a poster child of market aggression."