Crunch time creates mid-market private equity opportunities

According to Hamish Mair, Head of Private Equity Funds at F&C, the European mid-market provides a relative safe haven for private equity investors from the worst impacts of the credit crunch while the generally tougher lending criteria will actually create opportunities for new investors in terms of deal pricing and the secondary market.

"There is no doubt that the credit crunch is having a big impact on the large buy-out funds that have dominated the headlines for much of the last couple of years. While mid-market funds do have to cope with the reality that banks' lending criteria have become more stringent, groups operating in the mid-market have generally not relied on debt from large syndicates of banks and this debt is rarely, if ever, securitised. The impact of the credit crunch in this part of the market is therefore going to be much milder," said Mair.

Mair says that as a result of other parts of the same banks having to make balance sheet provisions relating to the US sub prime sector, credit committees are growing reluctant to authorise debt in the same quantities or on the same terms as before. He believes that this will have the impact of putting a brake on the acquisition pricing of businesses.

"From the point of view of F&C European Capital Partners, a fund that has raised cash but is largely un-invested," says Mair, "this is a positive factor, as it will hold back or lower entry prices therefore improving the potential returns that may be achieved by these investments as they are realised over the coming years."

From speaking to the private equity fund managers that F&C has made commitments to, the general feedback is that although the banking criteria have indeed become more stringent this has not led to deals failing to complete in the mid-market size bracket.
"This is not only due to the smaller size of the required lending but also to the modus operandi of mid-market managers who tend to have specific and long standing lending relationships with a limited number of banks. Beside from the softening in deal pricing, we expect to see very good secondary opportunities," says Mair.

"This is because under these conditions certain investors will arbitrarily allocate capital away from private equity. In these circumstances it is not unusual for part or all of an already invested private equity portfolio to be available at a discount to Net Asset Value."

He argues that one of the catalysts could be banks reducing their private equity exposure due to capital adequacy requirements.

"It is important to note that there is no credit crisis amongst private equity backed companies in Europe. The assets of private equity funds are cash generative companies which can still repay debt and interest. Clearly a broader economic slowdown reflecting reduced confidence may change the fundamentals but private equity is not especially vulnerable and indeed the controls and discipline which the private equity investor brings to their investments should stand them in good stead. One very clear consequence of the reduced appetite for banks to lend is that mezzanine funds, an alternative source of finance will see strong deal flow on advantageous terms. F&C European Capital Partners LP already has several mezzanine funds in its portfolio," concluded Mair.