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Annual Market Trends 2010

Balancing Fund Raising,


Financing, Deal Flow & the Economy

Kasriel Brown Lanser McDermott

Economic Overview
Paul L. Kasriel, Chief Economist, The Northern Trust Company
Panelists
Kenton L. Brown, Partner, William Blair & Company
Howard P. Lanser, Director, Robert W. Baird & Co.
Susan N. McDermott, Senior Vice President & Director or Research, Stratford Advisory Group, Inc.
ACG Chicago
March 4, 2010

ANNUAL MARKET TRENDS BREAKFAST

Presented by:

Susan N. McDermott, CFA


Senior Vice President/Director of Research
Stratford Advisory Group, Inc.

2
 Investment Policy

 Asset Allocation

 Investment Manager Selection

 Performance Evaluation

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 Illiquid Investments Increased
– Investment Policy Compliance Violations
– Debt Covenant Violations

 Increased Monitoring of Liquidity

 Other Investment Problems


– Hedge Funds
– Fixed Income Managers
– Securities Lending

4
 Other Investment Opportunities
– High Yield Debt

– Distressed Debt

– Government Sponsored Programs (PPIP/TALF)


– Secondary Fund of Funds

 Asset Allocation Reviews

 Liquidity Concerns Continue

5
 Distressed Real Estate

 Assuring Vintage Diversification

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Investors View
as Best
Opportunities

Investors
Seeking to
Invest in
2010/11

Investors
Avoiding

Proportion of Respondents
Source: Preqin

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Source: Preqin

8
Decrease
Allocation

Maintain
Allocation

Increase
Allocation

Source: Preqin

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March 4, 2010
Overall M&A Market Environment

Total U.S. M&A


($ in billions)

 2009 recorded a second straight year of declines in


M&A activity

 However, after surviving a market that was virtually


closed in the first half of 2009, the resurgence of
large, strategic activity in Q3-Q4 2009 should
provide momentum for 2010

Middle-Market U.S. M&A  Banks are still selective, but capital is readily
available for large-cap deals and financing is
($ in billions)
becoming more available for the middle market

 The economy will be the wild card: the market tone


now is positive, but any hint of double-dip will roil
the credit and M&A markets

_____________________
Source: Dealogic and Robert W. Baird & Co. Incorporated M&A Market Analysis. YTD as of February 28.

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M&A Transaction Volume
Transaction volume in the middle-market and the large-cap markets seems to be rebounding

Middle-Market U.S. M&A Activity Large-Cap U.S. M&A Activity


($ in billions) ($ in billions)
Number of Deals Deal Value Number of Deals Deal Value

Deal Value
# of Deals
# of Deals

Deal Value

_____________________ _____________________
Source: Dealogic. Source: Dealogic.
Note: Middle-market defined as deals with a disclosed transaction value of less than $1 billion. Note: Large-cap defined as deals with a disclosed transaction value of greater than $1 billion.

2
Impact of Leveraged Loan Volume on the M&A Market
Leveraged loans vs. M&A deal volume

 Credit issues affecting the overall markets have significantly reduced middle-market lending volumes over the last 12 months
 However, liquidity began to return to the market in the second half of 2009, which has been supporting increased M&A activity

($ in billions)

Leveraged Loan Volume


U.S. M&A Deal Value

_____________________
Source: Standard & Poor’s M&A Stats and Dealogic.

3
U.S. Total Private Equity Activity

($ in millions)

Deal Value
# of Deals

Undisclosed Deals Middle Market Deals Greater than $1B Total Disclosed Deal Value Middle Market Deal Value

_____________________
Source: Dealogic and Robert W. Baird & Co. Incorporated M&A Market Analysis. YTD as of February 28.
Note: Middle Market transactions defined as those with a disclosed transaction value of less than $1 billion.

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U.S. Middle-Market Valuation Multiples
Given the turmoil in the economy and credit markets, 2009 M&A valuation multiples significantly
contracted through Q1 2009; but a recent uptick in valuations suggests the market may have
“bottomed”
U.S. Middle-Market Annual Median Multiples U.S. Middle-Market Quarterly Median Multiples
EV/EBITDA

EV/EBITDA

_____________________ _____________________
Source: Capital IQ. LTM as of February 28. Source: Capital IQ.

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Middle-Market Transaction Multiples Analysis by Sector
Most sectors have experienced multiple contraction since the 2007 peak

Median U.S. EV / EBITDA Middle Market Multiple Analysis by Sector

_____________________
Source: Capital IQ.
Note:The multiples reported above reflect disclosed transactions and exclude multiples greater than 20.0x except for the technology sector which excludes multiples greater than 30.0x. Middle market transactions defined as those with a disclosed transaction value of
less than $1 billion. LTM as of February 28.

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2010 M&A Outlook
Hope Springs Eternal

 The surge in M&A activity in the second half of 2009 should provide the momentum needed for a rebound
in M&A activity in 2010
 Large, game changing deals seemed to be announced weekly (Dell, Xerox, Disney, Kraft)
 M&A topic at the top of board agendas
 Buyer / seller expectations more in line
 Banks continue to be selective in lending, but credit now seems to be readily available for quality M&A
transactions at increasingly attractive rates and terms
 Robust high yield and leveraged loan markets will continue to drive large-cap transactions
 Liquidity rapidly building for middle-market transactions in early 2010
 Backed by large cash hoards and access to capital, strategic acquirors should be increasingly active
 On the sponsor front, activity will reemerge in 2010
 Estimated $400 billion of cumulative uninvested PE capital on sidelines
 However, exits through an IPO rather than a sale may lessen M&A activity from sponsors

 The economy is the wildcard: any hint of a double-dip recession could roil the credit markets and M&A
activity would in turn dry up

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ACG Chicago – Market Trends Breakfast
Conditions/Trends in the Leverage Finance Market

Kent Brown
Principal – Debt Capital Markets

March 4, 2010
In 2009, Banks were Focused Inwards, not Outwards . . . . .

Playing defense with current portfolio (amendments,


workouts)

Pleasing bank regulators (OCC/FDIC)

Raising loan pricing (spreads, floors, fees, OID)

Improving structure (security, covenants, leverage,


amortization)

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… As Problem Loans Consumed Lender’s Attention ….
Lagging 12-Month Default Rate by # of Issuers # of Issuers in Payment Default or Bankruptcy

8.18%

Source: S&P LCD LoanStats Weekly Source: S&P LCD LoanStats Weekly

Number of Amendments by Quarter


 Loan defaults accelerated in 2009

 Amendments reached record levels as issuers


sought covenant relief and extensions

Source: S&P LCD LoanStats Weekly


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…. With Little New-Loan Activity to Pursue ……
2009 New Issue Volume
U.S. Leveraged Loan Volume
By Purpose
($ in Billions)

Corp. Purpose and


Other – 16% Refinancing – 49%

DIP – 11%

M&A (non-LBO)
– 19%

LBO – 5%

Source: S&P LCD Quarterly Review and S&P LCD LoanStats Weekly. Source: S&P LCD Quarterly Review.

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… But Default Rates and Amendments Have Peaked ….

Annualized 3-Month Default Rate


(By Principal Amount)

Source: S&P LCD.

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…. And Loan Valuations Have Rallied …..

Average Bid Prices of Selected Large Institutional Leveraged Loans (% of Par)

91.9%

63.5%

Source: S&P LSTA Secondary Spreads

Average Spread to Maturity – S&P’s B+/B1 Index (BPS)

L+1,389
L+416

Source: S&P LCD LoanStats Weekly.


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Average Debt/EBITDA Multiples (Middle Market Loans)

Leveraged multiples tightened in 2008-09, but began to rebound earlier this year.

Source: S&P LCD – Middle Market Review; Middle Market Loans (EBITDA <$50 million)

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Average Equity Contributions in LBOs

Equity contributions have increased considerably to fill the funding gap.

Note: Includes rollover equity.

Source: S&P LCD Quarterly Buyout Review.

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Loan Pricing
Spreads for leveraged loans have increased to 500-600 bps over Libor...
…however, all-in interest rates are close to long-term averages.
Average Spread of B+/B Institutional Loans

Before Now
Libor 5.0% 0.25%

Libor Floor -- 2.0% – 2.5%

Spread 2.5% - 3.5% 5.0% - 6.0%

Rate 7.5% - 9.0% 7.0% - 8.5%

Source: S&P LCD – Quarterly Review

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Recent Middle Market Sponsor Financing Activity

Effective Ranges

LIBOR Floor LIBOR Spread OID Senior Leverage Total Leverage Equity
2.0%-2.5% 500-650 bps 97-99 2.5x-3.0x 3.5x-4.5x 40-50+%

Source: S&P LCD Weekly Wraps.


Lender Checklist
Lenders are re-emerging, but taking a more cautious approach to new credits

 Steady performer (in / out cycles)  Asset coverage

 Defensive industry  Low leverage / high coverages

 Deep pockets (private equity firm)  Syndication titles / fees

Customer, end market and product Lower “hold sizes” and unfunded
 diversification
 commitments

 Near-term potential for fee-income /  Club-role (vs. participation)


deposits

0
Current Outlook

 Slow / modest recovery seen for 2010

 Deal flow still slow, but improving

 Mounting signs of optimism in credit markets

 ABL available - - - cash flow senior loans less so

 Loan terms improving (leverage, pricing) although very deal & sector specific