(Bloomberg) -- A multi-year drought in M&A has left Wall Street banks at the mercy of private equity firms, who are now calling the shots in the few deals that come to market.
PE firms, also known as sponsors, rely on debt to fund their acquisitions and lenders make some of their biggest profits from underwriting the deals. Demand for those transactions — called leveraged buyouts — has been growing lately as risk appetite rises with falling interest rates, but there’s also been a dearth of good opportunities for banks to get involved in.
The mismatch means sponsors have the upper hand when deals do arise and they’re using it to squeeze lenders for terms they otherwise wouldn’t get. That’s left banks taking on riskier deals, creating less room to sell the debt to investors if conditions change. Lenders faced a similar situation two years ago after they backed big buyouts and ended up saddled with tens of billions of dollars in hung debt.
“There is a thirst among lenders and investors to finance as many M&A processes as is possible,” said Jeremy Duffy, a partner at law firm White & Case LLP, who covers leveraged finance. “The imbalance around the number of acquisitions to be debt financed and the volume of lending pool participants is leading to some creative and clever offerings.”
Firms including The Carlyle Group Inc., Clayton, Dubilier & Rice LLC and Brookfield Asset Management have all pushed the boundaries on what’s normally accepted in recent transactions, according to conversations with around a dozen bankers, lawyers and investors used throughout this story, who asked not to be identified as the negotiations are private. Spokespeople for all three firms declined to comment.
Buyout Bait
A deal recently secured by banks to underwrite an €8.65 billion ($9.1 billion) debt package backing CD&R’s purchase of a stake in Sanofi SA’s consumer health division is a good example of how much sway sponsors now have.
CD&R told bankers that if they wanted to secure a spot on the financing package, they would also have to commit more than €1 billion of debt collectively to help fund the New York-based firm’s equity check for the deal.
Banks don’t normally like providing this kind of debt because they have to keep the deeply-subordinated loans on their balance sheets, and hold capital against them for regulatory purposes. But 22 signed up anyway, an abnormally large number of lenders for this kind of deal. In the end CD&R didn’t use the back leverage because it managed to raise other junior debt within the capital structure, but it was there to use if they needed it.
In another recent deal, lenders including JP Morgan Chase & Co. agreed to a capped price to underwrite a high-yield bond for Carlyle and Investindustrial Advisors SpA’s refinancing of Italian design firm Flos B&B Italia.
Capped prices are usually only used for leveraged buyouts where banks are handsomely paid in exchange for taking the risk. But because banks are carrying so little risk on their books due to the low volume of M&A, sponsors were confident the request would be approved, according to one person familiar with the deal. JP Morgan and Investindustrial declined to comment.
Other private equity sponsors are thinking longer-term. The initial fine print for a €1.95 billion debt raise to help fund KKR’s bid to break up media giant Axel Springer included terms that would have prevented lenders from banding together in the case of a restructuring, according to people familiar with the financing. Although banks were willing to accept the condition, it was dropped after investors said they wouldn’t buy the debt further down the line, the people said.
Excel Negotiations
Bankers say they’re also noticing changes in the way conditions are presented to them. Terms are often given via Excel spreadsheets, in which bankers are asked to suggest their most competitive offerings, some of the people said. Complex conditions are laid out without much detail and banks feel under pressure to agree to as many items as possible if they want a chance to be involved in the deal.
Banks involved in a pitch to underwrite an €11 billion ($11.6 billion) debt package financing a purchase of drugmaker Grifols SA by Brookfield were presented with more than 100 terms in an Excel sheet in a negotiation process that lasted for almost six months. Eventually Brookfield walked away from the deal due to a disagreement over valuations.
In some cases, bankers skim over the items so they can go back to the sponsors quickly and agree to terms without reading them thoroughly, the people said.
One glimmer of hope for bankers is that the M&A market is slowly picking up and many are betting that US President-elect Donald Trump’s business agenda will free up more cash for acquisitions via corporate tax cuts and lower regulatory barriers.
Still, Giacomo Reali, a high-yield partner at Linklaters LLP, says that part of the reason private equity firms are taking the upper hand is that they’ve invested in better capital markets desks, meaning they are less reliant on asking the banks for advice on what terms to push for — something that used to be common practice.
“Capital market desks at private equity firms are now super sophisticated,” Reali said. “So they’re calling the shots in leveraged buyout financings.”
(Updates to add detail on M&A market outlook in third to last paragraph.)
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