Midway through 2016, deal multiples in private equity and merger and acquisition (M&A) transactions in the U.S. have climbed almost a full turn higher than the levels seen in 2015, sitting at 11.3x (EV/EBITDA*). This is further evidence of a frothy environment and the continuation of the valuation increases we have seen over the last several years. Of note, the debt ratios and debt-to-equity mix used to fund M&A transactions have started to tick downward in spite of the higher deal multiples, 5.5x (Debt/EBITDA) and 49% (Debt/EV) in 2016 compared with 5.8x and 56% in 2015.
Transaction sponsors are likely concerned about the ability of companies to service ever-increasing debt levels, to say nothing of the challenges in securing additional financing for transactions. In response, sponsors are using more equity to fund deals. Both of these factors may be signaling that the post-financial crisis boom in leveraged buyouts may be starting to lose steam. Highly-levered companies and lenders who issued inexpensive covenant-lite loans could come under pressure. High valuations and elevated debt levels will continue to be a headwind for traditional buyout managers looking to put capital to work. On the flip side, such an environment can create opportunities for those with expertise in restructuring. The market is anticipating this turn as evidenced in the fundraising market that saw more capital raised in distressed strategies in the first half of 2016 than in all of 2015.
Key Takeaway:As the credit and M&A cycles enter their later innings, it will create opportunity for those with dry powder and expertise to restructure/re-price those transactions completed over the last several years, which were built on lofty valuations and structured with aggressive amounts of debt.
*EV- Enterprise ValueEBIDA – Earnings before interest, tax, depreciation and amortization
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