Private equity puts L back into LBO

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The success of a leveraged buying strategy depends largely on the availability of leverage. When debt is tight and expensive, it’s hard for private equity investors to close deals. This was one of the reasons for the recent LBO shortage. This trend is now reversing. Sponsors put the “L” back in LBO.

Take a look at the spin-off of Sanofi’s consumer health business, Opella, valued at around €15bn. The French pharmaceutical group is taking a two-pronged approach. It is considering a potential spin-off, but has also tested its appetite for selling about half of the business to private equity. It reportedly received offers from Clayton, Dubilier & Rice and PAI Partners, highlighting the renewed ebullience of debt financiers.

Lex understands that more than 20 banks have shown interest in financing a business. Between banks and private lenders, the bidders have amassed total debt packages equivalent to 7 times this year’s estimated ebitda of perhaps €1.15 billion. The lion’s share of this, approximately 8 billion euros, is the senior debt. The junior debt tranche – around €1 billion – includes a payment-in-kind option.

This is a substantial funding package. In part, it reflects the fact that Opella is a successful business coming off a dry spell, so lenders are jockeying for position. But the leverage is starting to grow wider. In Europe, the percentage of deals completed between 6 and 7 times ebitda rose to more than 20% this year, according to PitchBook LCD data, a near-double from 2022 levels.

This reflects increasingly favorable conditions for borrowers. Interest rates have fallen. There is a lot of pent-up demand for high-yield debt from CLO funds and private credit investors. Banks competed to regain market share from private lenders. Overall, since the end of 2023, funding costs have fallen by about 1 percentage point for the average European LBO borrower, according to PitchBook LCD.

In addition to falling interest rates, looser strings bode well for a resumption of private equity activity. But it’s not a slam dunk. Valuations for sponsor-led deals are also on the rise, meaning that despite the availability of debt, bidders may need to raise large amounts of equity to complete deals.

The offers for Opella, for example, reached around 15 billion euros. This isn’t nosebleed territory, which entails a 16% valuation reduction over bigger rival Haleon. But at these levels and despite debt, around €7bn of the deal would need to be financed with equity. The fact that Sanofi aims to retain about half of the business makes the expenses more manageable, in this case. Those who run their calculation rules on other targets may find the task still daunting.

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