Private credit joins private equity to freeze out banks

Private equity group Thoma Bravo’s $6.6bn acquisition of last week came with a surprising twist in the deal documents: the absence of a traditional bank financing the leveraged buyout. 

Large debt-financed takeovers by the private equity world have historically been underwritten by household names on Wall Street, institutions such as JPMorgan Chase, Goldman Sachs and Bank of America.

Thoma Bravo’s private equity funds will stump up $4bn for ownership of, a mailing and shipping business with $758m in revenue last year.

To get its deal over the line, the group turned to four private lenders to provide the $2.6bn in debt financing. Ares, Blackstone and PSP Investments will provide the majority, with Thoma Bravo’s own lending arm making up the difference, according to people familiar with matter. 

The deal underscores the massive firepower private credit funds have amassed and how they are putting that cash to work to finance bigger takeovers, according to people involved in recent deals.

Cash sitting in such funds has grown to a whopping $364bn globally, according to data from Preqin, and more than $80bn has been raised so far this year, as low interest rates send investors hunting for higher yields in private markets. 

Often the funds are run by the same institutions that separately operate large private equity funds. Marquee names such as Ares, Apollo and Blackstone might compete for an acquisition and then end up as partners in the debt financing. Like Thoma Bravo in the deal, they might end up as both borrower and lender, private equity on the one side, private credit on the other.

“It reflects the massive amount of cash on the sidelines looking for yield coupled with managers increasingly attempting to be involved in not only the acquisition but all phases of the transaction,” said Matthew Mish, a credit analyst at UBS. 

The deal extends a long-cultivated relationship between Ares and Thoma Bravo. Ares led one of the first $1bn plus non-bank financings for the private equity group’s takeover of data analytics business Qlik in 2016.

Such private loans have been getting larger in the years since. In March, lender Owl Rock and a consortium of other funds that included Goldman Sachs’ private credit arm agreed to provide a $2.3bn loan to Thoma Bravo to fund its takeover of financial services software provider Calypso Technology.

Line chart of Share price ($) showing shares surge on leveaged buyout

Traditional bank financing remains the go-to for most takeovers. But the loans and bonds that the banks are underwriting are mostly sold on to a wide group of lenders, and so are priced based on the whims of the market. A sudden jolt of volatility or shift in investor sentiment can alter the financing terms of a deal. 

Private credit funds proffer that companies are turning away from bank financing for increased confidentiality and greater certainty of receiving the funds, along with a faster turnround time between agreeing the deal and securing the cash. 

“In large take private transactions like, companies find that scaled private capital providers such as Ares offer several significant competitive advantages versus using a syndicate of banks,” said Kipp deVeer, head of credit at Ares Management.

However, it comes at a cost and in more subdued markets, especially when there is significant demand among a broader swath of credit investors, it is typically cheaper to borrow through bonds or loans organised by the banks, according to multiple investors and bankers. 

“You pay up slightly [for private credit funding], but it’s insurance cost,” said one banker involved in debt syndications. “You know you can get a deal done with them. You are paying for certainty. In a volatile or uncertain market you are willing to pay that.”

The growing power of private credit funds also reflects the shift in risk appetite that has filtered out through financial markets since the 2008 crisis, with banks stepping back from large, highly leveraged financings. New, non-bank players have increasingly stepped into the void. 

Their growth raises a question about whether the competition to deploy funds will raise risk in the system.

Private equity firms have already shown their willingness to stretch to clinch a deal. The average purchase price of buyouts in the fourth quarter of 2020 was 12 times earnings, according to S&P Global’s LCD, eclipsing a full-year record of 11.5 times set in 2019.

The deal will put the company’s debt-to-earnings ratio at more than 8 times, according to people familiar with the terms, more leverage than banks regulated by the Federal Reserve, FDIC and Office of the Comptroller of the Currency are typically comfortable guaranteeing., Thoma Bravo, Ares and Blackstone declined to comment. PSP did not respond to a request for comment.

Elizabeth Carson, a lawyer at Reed Smith, said the financing involved in the deal was a “stunning amount”. 

“It will be very interesting when the music stops,” she said. “But given the experience of the last 18 months, I think people are either hoping it won’t or figure they keep deploying [cash] until it does so they don’t miss the upside.”

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