NEW YORK, March 25 (LPC) - Private equity firms sitting on a stockpile of cash are eyeing companies that have dived in value as the coronavirus pandemic causes a sell-off across financial markets. Standing in sponsors’ way could be the flexibility some banks are demanding, concerned about lending into an economy on the cusp of a recession.
With memories of the 2008 financial crisis on many bankers’ minds, lenders are being cautious in extending credit, ensuring agreements include strict so-called ‘flex language.’ This flexibility allows lenders to increase the rate companies pay to borrow, which in some instances has been a deal-breaker for sponsors.
Concerns about the fast-spreading virus have sent markets into a frenzy. The Dow Jones Industrial Average fell almost 35% since the start of the year through Monday, but rose Tuesday on optimism the US Congress was close to finalizing a stimulus package. The LPC 100, a cohort of the 100 most liquid US loans, dropped more than 20% since the start of February to 78.54 cents on the dollar Tuesday.
Some of the largest private equity shops are sitting on roughly US$2trn in cash, according to a March 18 report from Morgan Stanley, and are keen to capitalize on the dip in valuations. There are potential targets that could go for prices significantly cheaper than just a few weeks ago.
“Most private equity firms have a ton of dry powder to put to work and have been complaining about high valuations,” said Jake Mincemoyer, head of law firm White & Case’s Americas banking unit. “If there is a reset on equity valuations, there could be a ton of activity once things settle down.”
Any activity, however, may take time to play out as financial markets navigate the new terrain brought on by the dislocation created by the coronavirus.
The virus has interrupted supply chains, closed retail operations and reduced consumer demand, pushing the world economy toward a recession.
In the immediate-term, private equity firms are expected to focus on their existing portfolios and ensure companies have enough liquidity, Morgan Stanley analysts wrote in the report. Buying opportunities may be available but sponsors’ access to financing will be limited.
“Private equity firms have assets to harvest, and their (immediate) priority is protecting the value of these assets and stress-testing them,” said Todd Albright, chief revenue officer at Datasite, formerly known as Merrill Corp, a software services provider focused on the lifecycle of mergers and acquisitions.
At least 14 loans worth about US$19.25bn in the US have been pulled since February 28, according to Refinitiv LPC data. Concerns about access to capital have prompted companies including hotel operator Hilton Worldwide and automobile manufacturer Ford Motor Co to draw on their credit lines.
As companies shore up their cash balances, it likely won’t be until the second half of 2020 before private equity shops move on businesses they’ve eyed in the past, the Morgan Stanley analysts wrote.
“The bigger issue is uncertainty, including duration and severity, and how to determine what valuations truly are,” said Jay Kim, a private equity partner at law firm Ropes & Gray. “While there is an opportunity for private equity to use dry powder, the coronavirus pandemic clouds the sale process due to the uncertainty of the valuations, which also affects (the) ability to raise financing.”
Lenders have been speaking with their legal counsel, trying to determine if the new market reality would allow them to drop out of committed financings or not fund existing revolving lines of credit. They are looking to see if the fallout from the coronavirus constitutes a so-called material adverse change or if a company’s financial health has deteriorated so that it may not be able to provide a solvency representation indicating it could repay its debt.
For new deals, banks are requesting more flexibility in pricing when committing to new acquisition and buyout financings, Mincemoyer said. And there has been a general tightening of language in documents with regard to shareholder dividends and investment availability.
In some instances, the additional flex banks have required has risen by about 100bp, according to two sources, while the starting interest rate companies would need to pay to borrow also jumped. After loan prices plunged in recent weeks, one banker said new financings would need to be extremely enticing to convince institutional investors to buy a fresh deal rather than purchase something at a discount in the secondary market.
For now, private equity shops are focused on ensuring their existing investments have enough cash to navigate life after the coronavirus.
“Markets are dealing with aspects of liquidity and are in a wait-and-see mode. After this, comes the unfreezing of the capital markets,” Albright said. (Reporting by Kristen Haunss and Aaron Weinman; Editing by Michelle Sierra)